How are inflation and return rates determined?

How are inflation rate and nominal rate of return on Regular Assets used and how did you choose the default values?

You can read this page to learn more about deterministic and stochastic planning approaches and how they work in MaxiFi Planner.

Taxes, Social Security benefits, the real (inflation-adjusted) cost of your mortgage payments and many other variables depend on future inflation. Hence, under MaxiFi's hood, the inflation rate you set plays a key role in calculating your household's sustainable living standard. That said, MaxiFi reports all its results in today's (inflation-adjusted) dollars. The inflation rate is used throughout all of our calculations to express all amounts in today's dollars.

We use the nominal safe rate of return on Regular Assets in conjunction with the inflation rate to determine the real interest rate -- the rate of interest above inflation -- that you earn on your Regular Assets. The real interest rate is roughly equal to the difference between the rate of return and the inflation rate you specify.

We base our default nominal rates of return on the 30-year nominal Treasury bond yield. To determine default long-term inflation expectations we subtract the 30-year Treasury Inflation-Protected Securities (TIPS) yield from the Treasury bond yield. We adjust these values if needed in early January and July of each year based on average daily yields on 30-year nominal Treasury bonds as well as 30-year TIPS in the prior months of December and June, respectively.

We urge you to adopt our default values for the rate of return and inflation. Entries that produce much higher or much lower safe real returns are not, in our view, appropriately cautious and may lead you to spend, save and insure more or less than you should.

If you hold risky assets, but are concerned they will lose value and are not running our Monte Carlo Risk Analysis, simply assume this has already happened and enter a smaller amount of Regular Assets. Similarly, if you hold cash, which you expect to lose purchasing power (due to inflation), simply assume this has already happened and exclude some of your cash holdings from your plan.

We also use your safe real interest rate when calculating the present value of your Lifetime Discretionary Spending. We discount (make less of) amounts of discretionary spending in future years. Once we discount each future year's discretionary spending, we add the annual discounted amounts together to determine their total lifetime present value. The same procedure is used to form present values of other variables shown in MaxiFi's lifetime balance sheet.