The Hedonic Pleasure Indexâ„¢: An Enhanced Model for Spending Inflation

Shambo, James A.
November 2008
Journal of Financial Planning;Nov/Dec2008, Vol. 21 Issue 11, p44
Academic Journal
• This paper challenges the accepted use of the Consumer Price Index as the benchmark for spending inflation in simulation software and safe-initial-withdrawal studies. • The author deconstructs CPI-U to explain why the price index is a poor measure of spending inflation and proposes an afternative measure (the Hedonic Pleasure Index™) based on individual consumption growth. • This paper uses data from the Bureau of Economic Affairs' "Personal Consumption Expenditures" from 1929 through 2006 and the Bureau of Labor Statistics' annual Consumer Expenditure Surveys from 1984 through 2005. • The paper also reviews the "consumption function" an economic theory that offers startling yet simple insights into consumption behavior. It explains why consumption growth for some young, upwardly mobile clients will exceed CPI by 300 basis points annually for the next 30 years. • The paper provides advisors with a short consumption questionnaire to personalize clients' real consumption growth. The goal of the questionnaire is to convert the Consumer Price Index into a real spending index by asking behavioral questions and considering individual spending attitudes. • Simulation results using real consumption growth of 55 basis points during retirement required an additional 7.5 percent savings, which in turn reduced the safe initial withdrawal rate threshold by 30 basis points. The paper concludes that inflation assumptions in simulation software should focus on client consumption behavior, not government price indexes.


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