Why don't baseline expenses grow at the rate of inflation

The following is a not uncommon, and possibly confusing, situation you may encounter in an Income Lab plan: You are using a Monte Carlo analysis method (for example, Traditional Monte Carlo) and have set the average expected inflation to 3%. However, you notice that a baseline expense of, say, $10,000/year is not growing at 3% (to $10,300, $10,609, etc.).

There are several reasons this may happen:

1. The plan may be using an "Age-Based" or a custom income path
2. If the differences is only between the current year and the next year of the plan, this could be due to less than a year of inflation being applied.
3. The plan may not be set to the correct Analysis Method (you can check this in the plan's Advanced Settings), or you may not have set and saved the intended inflation rate.

The Effects of the "Income Path" on Expenses

If the plan has an "Income Path" that is not flat, meaning the path is not simply adjusted for inflation over time, baseline expenses will not grow exactly in line with inflation. For example, the "Age-Based" income path follows the so-called "Retirement Smile". This path features higher income and expenses earlier in the plan, with reductions over time as people age, followed by a slowing of these reductions or, in many cases, a rise in expenses toward the end of the plan. This path may have a shape that looks something like these examples, in real (today's dollars) and nominal (future dollars) terms.

Real (Today's Dollars)

Nominal (Future Dollars)

Baseline expenses are meant to show how baseline income will be spent. And so, they follow this path and will inflate as in the nominal picture shown above. That means they will rise over time with inflation, but their real value will go down. Combined, that means they will not rise at the same rate as inflation.

If you'd like to include an expense in a plan that doesn't follow the Income Path, you can enter it as an Other/Variable Expense.