What's the right number for inflation and inflation standard deviation?

[GDK]

If ever there was a question for which nobody has an answer, this is probably it. But inflation is either enemy #1 or close to it for retirement planning from what I can tell.

I use an average and standard deviation of consumer price index numbers back to the early 1990s -- 2.7% average and 1.1% standard deviation. I limit the averaging back to the early '90s because I believe that our government and/or the Fed now have methodologies to control inflation that were not in place and/or were not used in years prior -- especially many years prior. I've been told by the folks at Financial Engines that they use 3% for an average -- the rationale behind the 3% was unknown.

But these numbers are so hugely important -- what do other folks use? And perhaps more importantly, has someone of credible reputation had a revelation regarding guidelines and criteria for what a good guess would be for these numbers?

Any insights would be appreciated!

Thank you!

[FRPJunkie]

If ever there was a question for which nobody has an answer, this is probably it. But inflation is either enemy #1 or close to it for retirement planning from what I can tell.

I use an average and standard deviation of consumer price index numbers back to the early 1990s -- 2.7% average and 1.1% standard deviation. I limit the averaging back to the early '90s because I believe that our government and/or the Fed now have methodologies to control inflation that were not in place and/or were not used in years prior -- especially many years prior. I've been told by the folks at Financial Engines that they use 3% for an average -- the rationale behind the 3% was unknown.

But these numbers are so hugely important -- what do other folks use? And perhaps more importantly, has someone of credible reputation had a revelation regarding guidelines and criteria for what a good guess would be for these numbers?

Any insights would be appreciated!

Thank you!

Personally, I use 2.0% for the Inflation - Average field, and 1.0% for Inflation - Std Dev field.

Historically (going back many, many decades) the inflation average has been 3.22%:

https://inflationdata.com/Inflation/Inf ... lation.asp


But as you note, it's been been below that for 20+ years. Might it go up? Possibly. But I feel safe with these values. There is no right answer. Hope this is helpful.

[GDK]

Great data, thank you for the response!

[ebcinmv]

Updated info on inflation rates as of Jan 14, 2020:

https://inflationdata.com/Inflation/Inf ... aspx#table

The idea of using the mean and standard deviation of inflation rates since 1990 makes sense to me, given modern methods for managing inflation. I calculated these for 1990 to end of 2019, and the mean is 2.45%, SD = 1.1343.

Hope this is helpful to the next person wondering what to enter for these values!

[Tanker_62]

Great, that helps a lot! I did use the average inflation rate from 1990 to 2019, and I'm glad it was the right choice and that I wasn't grossly mistaken.

[Goldenbulldog]

Hi All,

I just found this support forum. Awesome to have others out there to collaborate with on this platform. Inflation is key these days! What is a reasonable standard deviation to use with the average? I am using 4% inflation given the current state of the world.

[jimr]

Generally, it's best to leave the inflation standard deviation input at zero.

The ability to change this was added by request so people could experiment with this. But in reality, stochastically varying inflation while also independently varying portfolio return doesn't have a lot of sound theoretical underpinning to it. The two variables can interact in unexpected ways and that's why it's best to just leave inflation std dev at 0.

If I had it to do again, I probably wouldn't even include inflation std as a changeable input.

[Goldenbulldog]

Thank you very much Jimr! Your inputs are greatly appreciated.

[target2019]

This thread provided a day or two of thought for me. All I can say is thanks! Maybe 3.0% is too high an average. Only the future will tell us.

[ochotona]

I read a suggestion on another place to apply 3% inflation to most everything, but 5% to healthcare alone. I thought that a was pretty good idea.