Tackling Inflation Head-on in Financial Plans
Inflation is an insidious pest in financial planning, threatening to erode wealth and present a misleading picture of long-term security. As with many bugs, however, its sting can be mitigated by heeding the risk and taking protective measures. We take a proactive approach on inflation at Altair Advisers – monitoring it closely, revising assumptions regularly, and building conservative but realistic projections into our clients’ financial plans.
Given the questions we get about it from clients, we decided to share our thinking in brief on this important topic.
How does inflation impact financial plans?
Inflation affects virtually every aspect of a financial plan. That includes tax brackets, exemptions, qualified plan contributions, calculations for future value and present trend value of money, projected income and expenses, and more. It is important to take inflation into account in order to estimate not just how much your retirement savings will be worth years from now but also the future cost of big-ticket items such as tuition and long-term health care.
How does Altair incorporate inflation into plans?
This is a frequent question from our clients. Tracking data and trends helps, but that’s not all we consider. With all issues we incorporate into our advisory model, we listen to clients and their needs, research what’s important to them, identify trends, come to reasonable conclusions, and incorporate it into our guidance. For inflation specifically, we compile overall growth assumptions for various categories in financial plans and customize them further based on individual circumstances and locations.
We review our assumptions for inflation growth in key categories every spring based on data through the end of the prior year and revise our methodology to implement in financial plans accordingly. Updates are made in our planning software every April, along with the most recent updates to Altair’s Capital Market Assumptions made by our Investment Committee. Inflation estimates are compiled annually in order to avoid intra-year plan fluctuations, avoid yo-yoing back and forth, and reduce administration burden.
How do we decide what inflation figure to use?
Our financial planning department evaluates data from the following sources in compiling an inflation estimate to apply to financial plans:
- Breakeven inflation rate: Market-based measure of expected inflation (the difference between yield of a nominal bond and an inflation-linked bond of the same maturity). A useful gauge because it historically tracks closely to CPI, although it changes frequently and varies across maturities.
- Fed target: The Fed’s main policymaking body, the Federal Open Market Committee, judges that 2% inflation over the longer run as measured by the price index for personal consumption expenditures is optimal for a stable monetary environment. Important because we know that policy decisions will seek to achieve 2%.
- CPI (Consumer Price Index): A gauge based on surveys of what households are buying. Important as a widely used measure but not the most reliable since consumers tend to underestimate their spending. Tends to be higher than PCE.
- PCE (Personal Consumption Expenditures price index): A measure of price changes in consumer goods and services based on what businesses are selling. Includes a broader range of expenditures than CPI. The Fed is said to focus most on core PCE – excluding the volatile food and energy categories.
How is future tuition inflation factored into financial plans?
Tuition inflation, counterintuitively, has been declining at both public and private colleges since the 1980s, data from the National Center for Education Statistics shows. But college costs remain daunting and are sure to climb significantly for those attending years from now. Tuition at elite and other colleges has been trending upward more sharply since 2020.
We intend to stay conservative in our projection for tuition inflation growth and thus have built an estimated rate of 4.5% into our financial models, which is above recent rates. Our financial planning department will revisit education and tuition data every 12 months based on the latest year-end figures. For families prioritizing specific schools in the future, we can pull those costs to come up with a more targeted projection.
How can you prepare for the uncertain future costs of long-term care?
Long-term care costs are unknowable and could range from zero to $20,000 or more a month, especially if in-home care is needed, making them impossible to project with any degree of reliability. Yet protective planning is essential, given statistical evidence suggesting the likelihood that care will be needed and the potential for astronomical long-term costs. According to the U.S. Department of Health and Human Services, 69% of people will require some kind of long-term care and 20% will require care for five or more years (the average is three years – slightly more for women).
Our assumptions methodology has three components that we review annually: duration, cost, and inflation. As with higher education, we want to be conservative in our projections for these costs. Our clients may pay substantially more than that. Our financial plans assume a cost that is the average of the 10 most expensive states (excluding Hawaii and Alaska) for private room costs as ranked by Genworth Financial. We also look at where the client lives and use their regional location if it is greater than the daily average.
We recently raised the projected duration to five years from four years in our assumptions while retaining 5% as an assumed growth rate. These conservative projections should help account for the possibility of longer and costlier long-term care being needed.
In sum
Unlike some pests, inflation cannot be controlled. Its presence is constant – unlike the periodical cicadas that emerge only once every 17 years. That makes it critical to track and project its growth and build assumptions into financial plans. Maintaining diligence on inflation is a vital part of the financial planning we do for our clients.
The material shown is for informational purposes only and should not be construed as accounting, legal, or tax advice. Although we made efforts to verify the accuracy of the information, Altair Advisers cannot guarantee its accuracy. Please see Altair Advisers’ Form ADV Part 2A and Form CRS at https://altairadvisers.com/disclosures/ for additional information about Altair Advisers’ business practices and conflicts identified.