I have a question about how "real dollars" work for future amounts.
I am 56 and expect to start Social Security at age 70 and live (for the purposes of the plan) to age 102. I've entered my current estimate from Open Social Security as $3,638/month "adjusted for inflation (real dollars)" for a duration of 33 years, 0 months.
By my calculation that should be 3638 * 33 * 12 = $1,440,648 in real (=current?) dollars. And indeed, the "Show Funding Sources" option shows a level $3,638 paying out each month through retirement, while some of the nominal cash flows decline in value.
But when I look at the Balance Sheet (Sankey diagram) the NPV of this income flow is just $810,236. That sure looks like it is being discounted by the expected inflation rate (2.1% in my scenario currently). But why would real dollars be discounted in that way? That $3,638 from today's Social Security estimate will actually increase to be $3,638 * 1.021 ^ 14 in 14 years when payments begin (stipulating the expected inflation rate). Wouldn't its value discount back to a real $3,638 today?
I'm sure I am missing a fundamental mathematical / economic concept here?!
What prompted me to dig into this was trying to correlate my results with this tool with the ERN spreadsheet, which has you enter cash flows month by month. It obviously ends up expecting much more future money available for spending because those dollars are not discounted at all (unlike nominal flows). But for SS that seems like the correct expectation.
) to age 102. I've entered my current estimate from Open Social Security as $3,638/month "adjusted for inflation (real dollars)" for a duration of 33 years, 0 months.The balance sheet is showing the present value of the income streams. The discount rate used to calculate present value of a real income stream is the real interest rate. i.e. the expected return of bonds shown in the "Expected Returns" section. Does that match the amount you're seeing in the balance sheet?Actually it seems like the discount rate being applied must be something other than the inflation rate shown of 2.1% (the default in my Advanced settings — I haven't changed it). I have a $43,000 one-time income item (nominal amount) for one month in 2037 that shows up on the balance sheet as $25,891. With a 2.1% discount rate that should be roughly $32,734. And indeed, that is roughly the amount that shows up in the "funding sources" view for that month. I just don't understand why the NPV of that cash flow in the balance sheet is different.
The reason future dollars have to be discounted to get its present value is that $1 today is becomes $1(1+r)^t dollars in the future. This discounting is different from the inflation adjustment that converts between real and nominal dollars. Even inflation adjusted dollars have to be discounted using the real interest rate to calculate present value. Future nominal dollars have be discounted using the nominal interest rate, and future real dollars have to be discounted using the real interest rate.
Statistics: Posted by Ben Mathew — Sat Aug 17, 2024 1:26 pm — Replies 932 — Views 251002