Dont you feel like you are sometimes computing twice for inflation? For example Salary 100,000 Expenses 120,000 (increase by 1% because of inflation, so you do 121,200) Net cash needs = 21,200 Asset base = 300,000 Required nominal return for the next year = 21,200/300,000 = 7.07% + 1%. If you are already computing the 1% increase of inflation at the expenses, it feels like you are already considering that nominal increase on your calculations, specially because n=1 and its not like you need to consider for some future inflation or something. However, you do consider it at the end again. Any thoughts? Thanks
The 7.07% is real return, not?
(I have huge problems with inflation all over the place, I feel myself so stupid for this).
Yes…it would be what we call Real Return.
I can plug and play but I want to understand what I am doing.
Point being that you are already saying you want a real return higher because of the inflation on expenses…so your “real return” already has some inflation component. But then you say ok I want nominal return…lets add 1% for inflation again at the end.
I think the second +1% is not required as inflation. From the calculations I see you have already incorporated inflation in your calculations. That 7.07% seems is already nominal.
I might be mistaken, but I remember there was a topic in AF recently where someone added +1% for something like safety margin… if I’m not mistaken. unfortunately don’t remember the details, and couldn’t find actual discussion either.
Aha I see what you mean. Is this a question from somewhere and this is the answer? Add the 1% once again in the end?
This type of question also boggles my mind.
This question is basically on EVERY mock.
I think its core material so it does make sense to understand it.
The extra 1% is definitely for inflation (not some cushion), and is definitely not double counting.
Now that you’ve computed the nominal return for this year, apply it for next year and see what happens. That should clear up any problems.
Adding the 1% to the return requirement means you are also trying to maintain the purchasing power of your asset base which is 300,000.