Inflation is simply the rising costs of goods and services over time. It’s an important part of the planning process to make assumptions about buying power over time. It allows you to know how to budget your money using a placeholder that should represent to some academic degree the effectiveness of your dollar as you get closer to the time you need it. However, I have had several discussions with clients who assume the incline of inflation is something like 2% annually. And while that is a reasonable, and likely adequate initial placeholder, if your financial advisor is simply using that number because the talking heads on TV or the software they use have that number already baked in, then you need to have a serious discussion about the gaps that arise from such short cutting. A miss on the inflation discussion has two permanent repercussions on your financial plan: Inflation assesses its toll further and further into plans. It’s insidious and you won’t know the impact until the end of retirement, when you have fewer resources to make course corrections. It will affect what your expectation should be for your internal rate of return, particularly in your fixed income investments. If you are assuming a 2% inflation rate a 2% treasury may be appropriate, but if your personal inflation rate is actually 4% (likely from the reasons below) you will have an unaccounted for gap between the rising costs of goods and services and the yield from your chosen investments. This article is a good checklist to make sure that your financial advisor can discuss and will make adjustments for this gaps in inflation math: Your lifestyle No two retirees live the same lifestyle in retirement. If heard other advisors say that, and be able to adjust the product suite they use for risk, or which goals they bake into a plan, or even change the expected costs they use from goal to goal. But then each of them will extrapolate the costs of that lifestyle inflating at 2%. This is a mistake. This shows a lack of understanding as to what causes inflation and the effect it will have on your plan.  Inflation does not affect all products equally, in fact the most impacted items are usually isolated to the items that are purchased by everyone. Groceries, gasoline, and basic services are more impacted by steadily rising costs than that of large ticket consumer goods and electronics.  You may think that this isn’t a big deal right? We all buy groceries and that is a part of my financial plan. This type of thinking is ill-advised and offers a major gap in the calculations and the expectations you should have for your income.  Example: A client of mine said:  “I have a simple life, I don’t buy that many new things, and I’m not all that interested owning new cars, clothes and gadgets in retirement, my calculation for inflation should be pretty low.”  So he wanted me to lower his expected rate of inflation. I said wait a minute, you’re not thinking about that correctly, while yes, he is right that the things he buys may be simple and he’s not going to buy much, he’s wrong about the effect of inflation. Because he’s using the “2% average” he’s heard about he’s missed where the number comes from. The CPI is the change in a basket of goods and services, so it takes into account everything a regular american can reasonably buy (and it doesn’t include gasoline). So in aggregate the number may be 2%, but by not buying those items he’s taking on more, not less, inflation risk for the normal person. See in the chart below where we have eliminated the baskets he didn’t see himself buying (recall that the higher ticket consumer goods generally are disinflationary – the cost of a flat screen TV comes down with time and not up).  Item Annual change in inflation as a Percentage(%) Example clients inflation estimate Groceries +4% +4% Utilities +5% +5% Gasoline +5% +5% Movie Passes +4% +4% Healthcare +6% +6% Automobiles -3% NA Consumer Electronics -3% NA Clothing -2% NA Average 2% 4.8%   So while he is thinking that his appetite for spending is low, his exposure to inflation is more than twice the normal of people in retirement. So when we plan we are trying to extrapolate the costs of a certain lifestyle in retirement, in this scenario the inflation expectation should rise for this client, not fall. More severely, using a standard 2% inflation rate, will cause him to have a shortfall that becomes more complicated as he gets deeper and deeper into retirement.  Declining quality is inflation Several of the items that comprise your quality of life today, deteriorate in quality over time. This is not a hard and fast rule, and in some cases the opposite is true. But if you think about the nature of appliances, automobiles, and other big ticket consumer goods they can become suspect. The refresh cycle for large appliances in the 1990’s was 20% longer than it is for today. This is the result of a few elements, the “smart” revolution and added technology creating more demand for new items, and the decline in their quality. Both of these are measured as disinflationary, the costs of these items have come down year over year, and the “features-scape” is expanding. This all seems disinflationary and in the CPI it’s measured as costs coming down on these items. And while that might be a true statement for someone, the Bureau of Labor Statistics “buys” these items year over year to test the market changes, and for most people this is actually hidden inflation. Here is the math. If the price of an item comes down year over year by say 4%, but the refresh cycle is impacted by anything greater than 4% in a year, the result for regular people is actually inflation, not deflation. Because the