Inflation-Adjusted Return – Definition, Formula and Example

When calculating the inflation-adjusted return, the nominal return of an investment is adjusted to reflect the changes in the purchasing power of the currency due to inflation. This adjustment is necessary because inflation erodes the value of money over time, reducing the real return on an investment.

The formula for calculating the inflation-adjusted return is as follows:

The nominal return is the return on the investment before adjusting for inflation, while the inflation rate represents the percentage increase in the general price level. By dividing the nominal return by the inflation rate plus one and subtracting one, the inflation-adjusted return is obtained.

For example, let’s say an investment has a nominal return of 8% and the inflation rate is 3%. Using the formula, the inflation-adjusted return would be:

This means that after adjusting for inflation, the investment’s real return is 4.88%.

Calculating the inflation-adjusted return is important for investors to accurately assess the profitability of their investments. It allows them to compare investment options and determine which ones provide the highest real returns. By considering the effects of inflation, investors can make more informed decisions and protect their purchasing power over time.

Definition

When calculating the inflation-adjusted return, the nominal return of an investment is adjusted to reflect the changes in the general price level. This adjustment is necessary because inflation erodes the value of money over time, reducing the purchasing power of investment returns.

The inflation-adjusted return is expressed as a percentage and represents the rate of return after adjusting for inflation. It allows investors to compare the real returns of different investments and make informed decisions based on their actual purchasing power.

It is important to note that inflation-adjusted return is not the same as nominal return. Nominal return only considers the percentage increase or decrease in the value of an investment, while inflation-adjusted return takes into account the purchasing power of those returns.

Investors use inflation-adjusted return to evaluate the performance of their investments in real terms and to determine whether their investments are keeping pace with or outperforming inflation. It helps them make more informed decisions about their investment strategies and adjust their portfolios accordingly.

When evaluating investments, it is important to consider the impact of inflation on the returns. Inflation can erode the purchasing power of your investment gains over time. To accurately assess the true value of an investment, you need to calculate the inflation-adjusted return.

Formula

The formula for calculating the inflation-adjusted return is as follows:

Where:

• Investment Return is the nominal return on the investment.
• Inflation Rate is the rate of inflation over the investment period.

By dividing the investment return by the inflation rate, we can determine the real return adjusted for inflation. Subtracting 1 from the result gives us the percentage increase or decrease in purchasing power.

Example

Let’s say you invested \$10,000 in a stock that returned 8% over a year. However, the inflation rate for that year was 2%. To calculate the inflation-adjusted return, use the formula:

Calculating the inflation-adjusted return allows you to compare the performance of different investments on a level playing field. It helps you make informed decisions by considering the impact of inflation on your investment returns.

Remember, inflation can significantly reduce the purchasing power of your money over time. By calculating the inflation-adjusted return, you can better assess the true value and growth potential of your investments.