plonkee money an english-er's thoughts on personal finance

January 13, 2009

what do you assume?

Filed under: banking and economics — plonkee @ 8:43 pm

Question everything.

I often do rough calculations on all sorts of personal finance topics. Most of these require some assumptions, and I tend to use the same assumptions all the time. But you should never take anything for granted, maybe my assumptions need to be questioned.

inflation

If I need to use an actual figure, I generally choose to assume that inflation will be at or around 3% indefinitely. I pick 3% because that’s the target rate that has been set for all of my adult life. This figure is more a guess than anything that I firmly believe in, because I my other assumptions tend to be explicitly dependent on inflation.

savings interest rate

If I’m doing a normal calculation, I assume that the current *best* savings rates will continue for the forseeable future. I don’t think this is actually accurate, but I think that it’s good enough for the short term, and its not normally a major issue if it is slightly out.

In a more abstract way, I always assume that savings interest rates will never really fall below the inflation rate. Or rather, that it will always be possible to earn interest on cash that beats inflation, although it may take a little work to find the best deal, especially when tax is taken into account. Part of the reason that I think this is as a kind of loose interpretation of efficient market theory.

wage inflation

For the last 30+ years wages have gone up at around 2% above the rate inflation (we really are better off than we used to be). Technology improves and processes get more efficient. I think this is likely to continue in the long term, but I’m perfectly willing to accept this may turn out to be wrong. I more firmly hold that my own wages will be increasing at around 2%-5% above the rate of inflation for the first 10-15 years of my career, and fully expect them to stagnate more after that point.

house price inflation

I live in the UK which has been experiencing cyclical boom-bust housing market nationwide for years. I assume this will continue for the rest of my natural life. But the UK is also one of the most crowded countries on the planet, we have restrictive planning laws, and the increase in the number of households is greater than the increase in the population – I also assume that this will continue into the very long term.

Based on all these things I generally assume that house prices will (only on average) increase at above the rate of inflation and generally hover around the rate of wage inflation in the medium to long term.

stock market returns

I usually use a reasonable estimate of 4% above the rate of inflation, because this is the figure that official estimates for pensions and the like use. I have absolutely no other rationale for this, other than that I expect it to be generally at or above the rate of inflation. Stock market returns are always assumed to be average annualised returns over a suitable long term.

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