Does a future change in the inflation rate reduce real returns going forward?

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Since returns for regular assets and retirement accounts are set using nominal rates, does adjusting the inflation rate in a future year reduce the real returns going forward?

If that's the case, then if one adjusts the inflation rate at a future year, one should also adjust the nominal rates of return for those accounts at that same future year. This nuance didn't occur to me until recently.

Comments

dan royer's picture

Yes, the nominal rate you enter is always relative, now and in the future, to the inflation rate you set. So if you set inflation at 3% and nominal return at 3%, ESPlanner will be revealing a 0% real return. Furthermore, if you schedule a change of nominal return to 5% at some point in the future, then at that point the real return will become 2% (per the 3% inflation setting).

Thanks for your response. This confirms what I thought. In my case, I had changed the inflation rate upward a few years in the future without changing the nominal rate of return, causing my real returns to drop significantly below what I had intended for most of my retirement.

dan royer's picture

Yes, but of course just because inflation goes up doesn't mean our nominal rates of return will go up to. :) Sometimes inflation eats away at our interest income in some periods more than others. The only asset class I know of that can be counted on to adjust to inflation is Treasury Inflation Protected Securities. TIPS.

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