When conducting retirement research it is nearly ubiquitous to use inflation— CPI — as the measure of “keeping up”. This carries over to early retirement research as well. One example is EarlyRetirementNow’s long series of articles on Safe Withdrawal Rates for early retirees.
The Ultimate Guide to Safe Withdrawal Rates - Part 1: Introduction
Update: We posted the results from parts 1 through 8 as a Social Science Research Network (SSRN) working paper in pdf…
In that series he writes:
We look at the sustainable withdrawal rates over 30, 40, 50, and 60-year windows
On the surface, that seems to make sense. If I’m planning for a 50- or 60-year retirement then I need to take inflation into account.
But I’ve come to have my doubts about that approach.
My doubts first began creeping up on me quite a while ago when I started thinking in detail about my own early retirement. Are my current expenses a good barometer of my future expenses? Sure, they are better than nothing or just guessing. But if you’re an early retiree you have a lot of your life ahead of you. With 50 or 60 years ahead of you your life — and thus your expenses — might change.
I don’t just mean the “obvious” things like maybe you get married, divorced, have kids, or develop a health or medical condition. While those are all certainly risks what I’m talking about are the systemic risks of generational change.
Here’s a simple example of what I mean:
Imagine you’re an early retiree in 1900 and planning a budget for the next 50–60 years. You budget doesn’t include electricity (since in 1900 your house wasn’t electrified), a car, gas, a telephone or associated bill, a washing machine, a refrigerator, and so on. By 1940 or so the average person would have all of those things.
When you are 65 and thinking about expenses for the final 20–30 years of your life I think it is reasonably okay to assume a level of “maintain the status quo”. (But even there, someone who retired in 1987 certainly didn’t have mobile phones or Internet in their spending plan but have added them.)
When you are talking a time span of 50–60 years I think that approach becomes less defensible. The world is going to change dramatically over that half century. Think about someone who retired in 1967 — before man had set foot on the moon and the US presence in Vietnam had just started ramping up —that retiree is now 50 years into retirement and might have another decade under EarlyRetirementNow’s 60-year planning assumption.
Let’s try to put a little bit of “crunch” around this. In 1901, the average annual expenditures for an American family were $769. 42% of that went to food. Only 19% of families owned a home.
Now let’s fast forward to 1950. If we look at an inflation calculator like
$769 in 1901 → 1949 | Inflation Calculator
The 2.08% inflation rate means $769 in 1901 is equivalent to $2,061.45 in 1949. This inflation calculator uses the…
then it will tell us that $769 in 1901 is $2,061 at the start of 1950. Except in 1950 the average expenditure was actually $3,808.
If you only kept up with inflation then you went from middle-class to poor.
(Along the way, only 28% of expenditures went to food and now 48% of families owned a home. So the composition of spending also changed dramatically.)
I think that’s important so let me restate it: If you all do is “keep up with inflation” then over 5 or 6 decades you will go from middle class to poor. This isn’t really a surprise. The whole point of economic progress is that wages should rise faster than inflation. (One of the larger economic questions today is why America seems to have experienced long-term real wage stagnation over the past few decades.)
Here are a few more examples:
In 1901 the average hourly wage in manufacturing was $0.23 an hour. If you “kept up with inflation” then you’d be making $0.62 an hour. Except by 1950 wages in manufacturing were actually $1.59 an hour.
In 1901 the average hourly wage in finance, insurance, and real estate was $0.25 an hour. If you merely “kept up with inflation” then you’d be making $0.67 an hour. Except people were actually being paid $1.46 an hour in those industries.
If all you do is keep up with inflation then over the course of 5 or 6 decades you will go from middle-class to poor.
That’s the macro-level view: you probably need to do more than just “keep up with inflation” when you’re talking about a retirement that is half a century long.
But a retirement that long also exposes you to other secular trends. Think about how national diets change over time. Here’s a quote from a BLS report on a century of spending trends:
The average American in 1950 consumed 3,260 calories per day compared with 3,250 calories a day in 1934–36, although individuals consumed 12.6 percent more food in 1950. During the Depression, the American diet was high in calories. By the 1950s, a greater selection of foods and widespread use of refrigeration had contributed to a change in dietary habits.
Now think about how those same trends continue today: you probably eat a lot differently than you did 20 years ago. You probably eat out a lot more. You eat a wider variety of food. A lot more “ethnic cuisine”. You may be spending a larger proportion of your budget on (Instagram-worthy) food.
That’s over a relatively short time period (15–20 years) and with just one category of spending. Now stretch it to 50 years and every aspect of your spending.
In the past 50 years food and clothing has gone from 42% of the annual budget to 17%. But other things — things that barely existed in 1950 — have gone from 21% to 39% of the budget. Cars. Gasoline. Higher education.
What things are going to become similarly “mandatory” over the next 50 years?
This isn’t to say that using CPI-adjustments isn’t a great starting point. And, yes, a fair amount of this can be handle via adjustments, flexibility, and tradeoffs. Maybe you spend more on robotic chefs in the future and less on robotic cars and find a way to make it work as your lifestyle and priorities change.
But — going back to the first point — if all you’ve done is “kept up with inflation” and you’ve gone from middle-class to poor over those 50 years then you lose a lot of flexibility.
So what would all of these early retirement studies look like if, instead of wanting to maintain constant purchasing power (adjustments according to CPI), we wanted to maintain constant socio-economic class (adjustments according to national wage increases)? That way, if we retire as middle class then 50 years later we haven’t slowly slipped into relative poverty and a half-century of economic progress lifts all the boats except for ours.