Nominal vs real returns
A nominal return is the number on your statement. A real return subtracts inflation. Earning 5% when inflation is 3% gives a real return of roughly 2%. Earning 4% with 6% inflation is a real loss.
How assets tend to respond
- Cash: loses purchasing power whenever its interest rate is below inflation.
- Fixed-rate bonds: fixed payments buy less, and prices often fall if rates rise to fight inflation.
- Inflation-protected bonds: designed to adjust with inflation.
- Stocks: companies can sometimes raise prices, but high inflation has often pressured valuations in the short run.
- Real estate and commodities: have sometimes kept pace, with wide variation.
Example
At 3% annual inflation, $100,000 buys about what $74,000 buys today after 10 years, and about $55,000 after 20 years. A plan that ignores inflation can look much better on paper than in real life.
Inflation and interest rates
Central banks often raise interest rates to slow inflation, which affects bonds and stocks in its own way. See the interest rates guide for more on that link.
Key takeaways
- Inflation lowers the real value of money and returns.
- Cash and fixed-rate bonds are most exposed.
- Always compare returns after inflation.