Inflation-Adjusted Return
Candlefocus EditorGenerally, inflation lessens the value of a currency and erodes the principal and potential return of an investment. An investor will calculate the inflation-adjusted return to compare the purchase’s real value, and better understand how much of the return was due solely to inflation.
By factoring out inflation, the inflation-adjusted return more accurately reflects the true return on an investment. For example, if a stock yielded a 5% return over a period of time and the equivalent inflation rate was 3%, the inflation-adjusted return would be 2%. This figure reflects the true return on the stock investment and accounts for the money lost to inflation.
The inflation-adjusted return can be compared to other historical or expected inflation rates to determine the true impact of inflation on an investment. A wise investor always factors inflation into their overall return calculations, accounting for all money lost to inflation. And smart investors will continually monitor the inflation rate to ensure their returns remain competitive.
Real returns also play an important role in retirement savings analyses. When calculating the estimated retirement savings needed to maintain a certain lifestyle, investors must take inflation into account and calculate the ‘real return’ in order to accurately gauge the purchasing power throughout retirement.
Inflation-adjusted return is a useful metric for investors and provides a more realistic understanding of an investment’s performance. While it can’t change the fundamental realities of the effects of inflation, it will help investors to make more informed decisions, compare investments over time, and better understand the return on their investments.