Dear Friends and Readers,
I’ve received a lot of kind feedback on my book, and a tiny bit of tough love. I appreciate both types of responses and I hope you’ll keep them coming.
Pilots take our work very seriously because lives actually depend on our ability to do it properly. Every training flight and serious military mission concludes with a debrief where we identify the good and bad from our sortie, and identify things to work on in the future. We regard these debriefs as almost sacred, and they come with some important ground rules:
- There is no rank in the debrief. If the Colonel Wing Commander screwed something up, the Captain Instructor Pilot addresses it.
- Take your spears. No matter how great or important you think you are, a pilot humbly accepts his or her critiques and tries to find value in them.
- All feedback is done with the ultimate goal in mind: making everyone safer and more effective at their mission.
In that spirit, I’m very thankful to the author of one of PMTB’s reviews on Amazon. I feel that the review was thorough, well-considered, and accurate. I only earned 4-stars in part because of how I didn’t go far enough in addressing the effects of inflation in my book. For the sake of transparency, here’s the full text from that section of the review:
My major beef (and it is fairly minor) with the pilot math portion of the book is that, while he acknowledges the role of inflation on page 104, he appears to totally leave it out of his calculations on page 69. While the average household spending as of 2016 was $55k+, accounting for inflation means that the pilot would need to spend $68k+ to afford the same expenses 7 years later just before their Captain upgrade. Then, the author suggests doubling the spending at Captain upgrade, but due to inflation, this will end up being actually closer to $140k in expenses than $115k. When the pilot retires in their 30th year, the expenses would increase to $235k annually – the equivalent of $115k in 2016 dollars. This is over double the expected expenses when the Captain first upgrades. Then, those expenses will again increase over time during retirement, either more quickly depleting the treasure bath, or requiring the pilot to work longer to get a self sustaining bath. The higher expenses in earlier years will no doubt reduce the power of compounding interest in the later years, since the pilot won’t be able to have as high of a savings ‘rate’. I will concede that he used today’s pay rates over thirty years, while pay rates would likely increase over time (though they have yet to keep up with inflation in my experience), so that might offset many of the increased expenses. He argues that he uses a conservative interest rate of 5% to account for some of this, though that means one would need an actual 8% interest rate over thirty years to account for inflation in order to make his numbers work. A minor point, but one that throws the calculations off a bit.
This is valid feedback, and I want to address it today. Even if I wanted to, it’s too late to change the charts in the book to reflect the increases that my reviewer suggests. However, I hope you’ll end up agreeing that Pilot Math has accounted enough for inflation to remain usable.
I’ll start with a small quibble. Yes, I could have overtly addressed inflation in the calculations in my book. I consciously chose not to, in part because the charts were already complicated enough. I had to try and keep them readable in paperback and eBook format. I’ve also posted the charts on my Calculators page so that you can download and customize them to your heart’s content. They’re pretty monstrous spreadsheets and I didn’t want to make them so complicated that they’d be impossible to figure out. (I hope to publish more user-friendly versions some day.) However, if you would like to adjust them for inflation, you’re welcome to do so.
Now, with that complete, let’s talk about inflation and how I addressed it in my Pilot Math.
First off, inflation sucks. If you ask 10 economists what causes inflation, you’ll get 435 different answers. The bottom line is this: over time, money tends to lose value. The US Bureau of Labor Statistics has a bunch of fancy tools to display historical inflation rates. Here’s annual inflation rates from 1957 to 2019:
Over the very long-term, we say that inflation averages somewhere around 3.0% per year. This means that if you stick a $1 bill under your mattress today, one year from now it will only be able to buy as much as $0.97 would have on the day you stashed it. That effect compounds as time goes on, just like interest in your investment accounts compounds in your favor.
Looking at this another way, if your family is able to limit spending to $57,758 (the value I use in Pilot Math Treasure Bath) this year, next year you’d have to spend $59,491 to buy the same amount of stuff. If this trend continued to Year 9 at a major airline (when I assumed you’d upgrade to Captain in the book) you’d have to spend $75,361 to get the same value that the $57K figure got you in Year 1.
In the book, I assume that you’ll double your spending to $115,516 after you upgrade, but my reviewer is correct in stating that inflation would require this figure to be much higher…somewhere around $150K in Year 9.
That’s a significant difference. At one point I calculated that a pilot’s total savings in Year 9 would be around $137,000. If we raised our spending figures to account for inflation, the total savings amount for the year would be more like $102,000. Does this completely destroy the whole theory of Pilot Math? I argue that it does not. However, this does mean that it would take longer to reach Financial Independence, the point at which passive income from investments covers all your annual spending needs.
(If you want to run some numbers for yourself, I used this calculator from bankrate.com. I just put the rate of return at 3% to show the effects of inflation.)
So what’s the deal? Why didn’t I show the effects of inflation directly in my charts?
The 4% Rule
Let’s remember that one of the key assumptions of Pilot Math is The 4% Rule. This rule says that if you have a nest egg, a pot of investments, as long as you only spend 4% of the total balance of those investments each year, they will effectively last forever.
I didn’t pull this out of thin air. This rule is based on a study conducted by three professors at Trinity University. The original study was published in 1998, and you can read an updated version of their study with newer data here.
The study didn’t start at 4%…it solved for it. The authors were trying to determine a safe withdrawal rate for retirees, under the assumption of a maximum 30-year retirement timespan. They wanted to know what percentage could a theoretical retiree spend per year without running out of money before he or she died.
They examined this question by looking at every 30-year timespan since 1926. This means they accounted for the Great Depression and every downturn since. Their conclusions were impressive. If you invest 100% in the stock market, a 4% withdrawal rate gives your money a 98% chance of lasting for a full 30-year retirement. That 2% failure rate probably represents a person who retired the day before the crash that triggered the Great Depression. Starting retirement at any other point results in success, when using past data.
It’s very important to note that this conclusion comes from Table 2 in the version to which I linked and that table accounts for inflation. My reviewer was right in that I don’t show how my numbers account for inflation, but the original Trinity Study upon which I based my assumption of a 4% withdrawal rate accounts for it whether I show it in my charts or not.
I suspect that my reviewer had never read the Trinity Study itself, but I hope that he or she will because it’s impressive!
It’s worth noting that not only does the study show that a 4% withdrawal rate has an inflation-adjusted 98% success rate, but that after 30 years the total balance of the investment account more than doubles, even if half of it is invested in bonds.
In the context of Pilot Math Treasure Bath, this means you could quit working, spend $57,758 from your Treasure Bath in Year 1, increase that spending to match inflation each year, and after 30 years your Treasure Bath would have more than twice as much money in it as you had in Year 1.
While this seems unbelievable at first glance, it’s borne out in the real-life example of Justin, the author at Root of Good. He retired in 2014 with a net worth of $1.3M. His family of 5 doesn’t quite spend 4% because they’re happy living on less. Still, as of October 2019 their net worth has climbed to $2.16M! It’s nearly doubled in just 5 years…far short of the 30-year timespan in the Trinity Study.
While my reviewer was correct in noting that my numbers didn’t show the effects of inflation on spending, he or she failed to give equal weight to the other side of the equation. It turns out that airline pilots get pay raises.
When I started at my airline in 2016, first year FO pay was about $70/hr. Toward the end of that year, we signed a new contract worth a lot of money. The total pay raise over the four-year contract was 30.1%. My first year FO pay immediately jumped 18% to $83/hr. (They even sent me a check for about $10K, making the pay increase retroactive to January 1st of that year.) If you look on airlinepilotcentral.com, you’ll see that first year FO pay is currently at $92/hr.
Over the last four years, that average pay increase of 7.5% per year has more than doubled inflation.
When asserting that I should have increased my annual spending numbers such that they would have hit $75K in Year 9, my reviewer should have simultaneously asserted that I increase my annual income levels to reflect a Year 1 FO pay rate that would rise to $178/hr over the same time period. This would have shown a given pilot’s income effectively doubling, while spending increased by less than 35%.
Instead, my reviewer asserted that pilot pay rates have failed to keep up with inflation, though I don’t see that in more recent data, at least for major airlines. One of the compounding effects here is that pilot pay at my airline took a 50% during a period of bankruptcies and mergers in the mid-to-late 2000s. Those pay rates have failed to recover to what they would have been in todays dollars. However, I feel cautiously optimistic, at least concerning the future of my company.
Now, I don’t think it’s realistic to expect pilot pay rates to increase by an average of 7.5% per year. If we carry that assumption out to the 30-year timespan of the charts in my book, first year FO pay hits something crazy like $814/hr. Not gonna happen.
However, I think it is fair to expect airline pilot pay to at least keep up with inflation, if not beat it by a little bit, over time. For my book, I assumed that the two would increase equally, and kept everything in current year numbers for the sake of simplicity.
Stock Market Performance
I also accounted for inflation by assuming low investment returns. According to Investopedia, the historical average annual return for the S&P 500 since 1926 is 10%. This index started with only looking at about 90 stocks. Since it expanded to include a full 500 companies in 1957, its return is closer to 8%.
Remember, this return reflects gains that happened despite covering a timespan that includes the worst Depression and other Recessions in recent history.
For Pilot Math Treasure Bath, I assumed investment returns of only 5%. I chose this number to reflect an 8% return as a conservative take on the expected performance of the stock market going forward, and then reduced that number by a flat 3% to account for inflation.
Ideally, my assumptions reflect returns so low that they’re unrealistic. I used these assumptions in the hopes of showing bad-case numbers, hoping that you would be happily surprised when your actual results exceeded all of my estimates. I can’t promise this will happen, but I believe I at least did justice to the idea of assuming conservative investment returns.
CPI vs Inflation for Spending
Although my reviewer’s math works if we want to assume that a pilot’s spending must increase with an average inflation rate of 3% per year, I think this assumption may be inaccurate. The US Bureau of Labor Statistics tracks a value it calls the Consumer Price Index, or CPI. This index shows the increase in costs for a specific set of consumer goods over a given period of time.
Although inflation does affect the economy overall, the prices for specific products don’t always track with inflation. In fact, the prices for some things decrease over time. Solar power, for example, is getting more affordable as time goes on. Electronics like mobile phones and personal computers were once so expensive that only the rich could afford them. Today, they’re so cheap that mainstream society almost looks at them as throw-aways to be replaced every couple years.
The CPI takes all this into account by looking at actual prices over time. When you look at historical data, the CPI averages lower than inflation. I feel it’s unrealistic to assume that my $57,758 spending figure would have to increase by 3% per year indefinitely. Yes, I could have adjusted it for CPI, but that would have again made things less simple.
Although my reviewer’s critique of the way I showed my math was technically correct, I believe he or she lacked the context for understanding that I did account for inflation in several ways. (I apologize for not explaining this in the book. I guess I’d better start working on the 2nd Edition!) Here’s the list of ways that my Pilot Math accounts for and/or works in spite of inflation:
- The Trinity Study that derived the 4% Rule accounts for inflation.
- Pilots get pay increases that frequently beat inflation. I did not assume any pay raises for the charts in my book. If I had, I would have at least assumed annual pay rate increases equal to inflation.
- I assumed investment returns far below the historical average. The S&P 500 averages more than 10% annual returns in the long run. Many analysts use 8% as a conservative estimate. I reduced that to 5% in hopes of showing investment performance that accounts for inflation. This effectively doubles the inflation protection assumed by the 4% Rule.
- Spending numbers probably will probably increase in accordance with the CPI, rather than raw inflation rates.
Thanks again to Draco_CJ for reading my book and giving such a detailed review on Amazon! Thanks for the candid feedback, and I pledge to do better in the future. I hope the context I’ve provided here alleviates some of your concerns about Pilot Math’s accounting for inflation. I hope you’ll apply the principles behind Pilot Math and work toward filling a Treasure Bath, regardless of the specific point at which you’ll reach Enough. I still assert that point is closer than you think.
Nos Amo Servo!