My net worth (total assets minus total liabilities) today is 6.3% higher than it was when I retired in 2019. This is in no small part thanks to stellar returns delivered by the financial markets since then.

What’s more, I have not incurred any catastrophic expenses; e.g., a costly medical diagnosis (knocking on wood). Five years into retirement, I’m a little more confident my decision to punch out at the tender age of 53 was a safe one.

Even if the next five years are just as bad for financial markets as the last five were good, I’ll be no worse off ten years post-retirement than when I retired.

There may lurk a fallacy in this optimism, however. It’s what the great twentieth century economist Irving Fisher called the money illusion, and I aim to explore its true hazards in today’s post.

My Net Worth

Here is a graph of my net worth, month over month, since my retirement in March 2019.

What useful information can be gleaned from this graph? For starters, note its title: Liquid Net Worth. Liquid here means money to which I have ready access, or assets I can convert to money easily. This includes cash in savings accounts, and investments in taxable brokerage and tax-deferred retirement accounts. Notably, it does not include home equity.

Why don’t I include home equity in my net worth? For a couple of reasons. First, I can’t use home equity to buy stuff (unless I turn it into a home equity loan, which I am loath to do). For this exercise, I’m only interested in money I can use to buy stuff.

Second, home equity can be tricky to quantify. What if my home requires $100K of improvements to fetch a price the same, updated model down the street just sold for? If I don’t account for this, I significantly overstate my net worth.

Including home equity in my net worth may make me feel better about my financial situation, but it’s probably best to exclude it from analyses of sustainable spending.

My Real Net Worth

The next graph is identical to the first, but I’ve added a new line (in red) called real net worth. The blue line is still there, but now I am calling it nominal net worth.

Nominal means in name only. That is, the name one dollar has the same meaning today that it did 100 years ago. Though the name hasn’t changed, the value of one dollar is much different than it was 100 years ago. This change is reflected in the real value of one dollar, which accounts for its loss in purchasing power over that period.

Whereas the blue line in the graph shows an increase of 6.3% since 2019, the red line shows a decrease of 13.9%. Thus the real, or inflation-adjusted, value of my net worth has actually decreased since I retired, and not by an insignificant amount.

Put another way, my 6.3% increase in net worth exists in a fantasy world in which there was no inflation between March 2019 and today. This is what Fisher was alluding to when he coined the term money illusion.

Inflation

While the blue and red lines diverge only slightly in the leftmost third of the graph, the widening accelerates markedly in the rightmost two-thirds. If it weren’t obvious why this is the case, the next graph should make it clear.

This graph plots the increase in consumer prices over the same period. I am using a measure preferred by economists, and a variant thereof most applicable to me: the Consumer Price Index for All Urban Consumers, or CPI-U.

Note the rapid steepening of the line starting around 2021. This is around the same time the blue and red lines on my net worth graph start to widen at a noticeably accelerating pace.

Cognitive Dissonance

If you haven’t felt the pain of inflation the last three years, congratulations. Either you have money to burn or, as a cave dweller, your cost of living isn’t measured in currency.

Many economists today are baffled by consumer pessimism, citing statistics that convince them the economy is booming. What they fail to consider is that inflation does not equal prices. The latter measures a quantity, and the former the rate of change in that quantity—apples and oranges. While inflation has come down, prices have not.

Compared to a few short years ago, current price levels are a shock to the psyche. This explains, at least in part, why so many of us feel lousy about the economy despite lower inflation.

The Markets

The next graph plots the change in the S&P 500 index over the same five year period as the previous graphs. The S&P 500 index is a good proxy for the total US equities market, in which a substantial portion of my liquid net worth is invested.

If you compare this graph to the one plotting my net worth, you will notice a distinct correlation. For example, note the substantial dip from January to March 2020. The same dip is clearly visible in the net worth graph.

What does this correlation tell us? For one thing, it reveals the extent to which my net worth is tied to the US equities market.

Some might consider this a dangerous, or even irresponsible, consolidation of risk. I admit that the degree of the correlation is a bit startling even to me. But when you don’t have enough to live off risk-free interest alone, you are somewhat beholden to the stock market circus.

Though it is more difficult to discern, the amplitude of the peaks and valleys in the S&P 500 index graph is greater than that in the net worth graph. This is because the whole of my liquid net worth is indeed invested more conservatively than the S&P 500 index. The next graph makes the point visually.

There is another important difference between the S&P 500 and net worth graphs. The former trends upward much more steeply than the latter. It should be obvious why this is the case. It is because the spend-down on my assets represents a significant drag on my net worth.

My Real Rate of Inflation

As important as it is to understand the difference between the nominal and real values of money, it is no less useful to distinguish official (nominal) inflation from personal (real) inflation. Official inflation is expressed in CPI-U. Personal inflation represents the actual change in what you spend.

Here is a graph that plots my spending, month over month, since March 2019.

Aside from the occasional months in which my spending exceeded $10K, it has remained fairly flat, despite the rapid increase in CPI-U. If I omit the spikes in the graph—the four $10K outliers—the trend is slightly upward. But it is so small that it is nearly imperceptible. Crucially, it is nowhere near as steep as CPI-U.

Does this mean that, despite the breathtaking increase in CPI-U, I have somehow magically dodged the effects of inflation? Indeed I am not immune to the effects of official inflation. Chief among these is the precipitous increase in interest rates that has accompanied it (I wrote about that here).

How is it, then, that I have managed to keep my spending flat? The short answer is that I have made conscious adjustments; spending less on discretionary items like meals out, expensive trips and other things I can still live comfortably without.

Just as modern refinements to Bill Bengen’s 4% rule call for belt-tightening in times of poor market returns, the same strategy can be employed in times of high inflation.

Related: What is Your Personal Rate of Inflation

Related: The Benefits of Gamifying Retirement Spending

Takeaways

The Bad News

I started this post by alluding to the pitfalls of conflating the nominal and real values of money; what Irving Fisher coined the money illusion. Fisher was so taken by the subject he wrote an entire book about it.

It is a fascinating topic, and deserves a deeper dive for anyone interested in the often bizarre psychology of behavioral economics.

It also suggests one might do well to recast a nominal increase in net worth in terms of real, inflation-adjusted dollars before pulling the trigger on that new Lambo.

The Good News

With the money illusion dispelled, I countered that the news is not all bad; that even if your real net worth has gone down, there is no need to panic.

To the extent there is a discretionary component to your spending, there is an opportunity to adjust it to protect yourself from inflation, even at the dizzying pace captured in official inflation numbers.

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[I’m David Champion. I retired from a career in software development in March 2019, just shy of my 53rd birthday. To position myself for 40+ years of worry-free retirement, I consumed all manner of early-retirement resources. Notable among these was CanIRetireYet, whose newsletters I have received in my inbox every Monday morning for the last ten years. CanIRetireYet is one of exactly two personal finance newsletters I subscribe to. Why? Because of the practical, no-nonsense advice I find here. I attribute my financial success in no small part to what I have learned from Darrow and Chris. In sharing some of my own observations on the early-retirement journey, I aim to maintain the high standard of value readers of CanIRetireYet have come to expect.]

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