How to Calculate and Leverage Inflation-Adjusted Returns
Understanding inflation-adjusted returns is crucial for any investor looking to build and preserve wealth over time. Inflation has a significant impact on the purchasing power of money, eroding the value of investments and savings. Knowing How to Calculate and Leverage Inflation-Adjusted Returns allows investors to accurately assess the true performance of their investments and make informed decisions to ensure their financial goals are met.
What is Inflation ?
Inflation refers to the rate at which the general level of prices for goods and services rises, resulting in a decrease in purchasing power over time. When inflation occurs, the same amount of money buys fewer goods and services than it did before. This phenomenon can be caused by various factors, including increased production costs, growing demand, changes in government policies, or fluctuations in currency value.
What is Inflation-Adjusted Return ?
An inflation-adjusted return is the measure of the rate of return on an investment after accounting for inflation. It reflects the real purchasing power that the investment provides after removing the eroding effects of inflation. Inflation-Adjusted Return is an important business and finance term as it provides a more accurate gauge on the actual growth or profitability of an investment, taking into consideration the effect of inflation. Standard return rates may not realistically reflect the true earning power of an investment as they do not account for the inflation rate. By using the inflation-adjusted return, investors can estimate the real value and future purchasing power of their investments.
How to Calculate and Leverage Inflation-Adjusted Returns
1. Calculate nominal return (investment return).
2. Determine inflation rate over the same period.
3. Subtract inflation rate from nominal return to obtain real return.
4. Use real return to accurately assess investment performance and make informed decisions.
Examples to understand
Inflation-Adjusted Returns in real estate market
Let’s consider a real estate investment where someone purchased a house for $200,000 in 2010, and its value appreciated to $250,000 by 2020, implying a gross return of 25% over the 10-year period. On average, this translates to a 2.5% return per year.
However, to assess the investment’s real return, we need to adjust for inflation. If the average inflation rate over the same period was 2% per year, the inflation-adjusted return per year would be approximately 0.5%.
Inflation-Adjusted Returns in saving accounts
Consider a savings account that earns an annual interest rate of 5%. If the inflation rate is 6% over the same period, the inflation-adjusted return (real return) on the savings would be approximately -1%. This means that after adjusting for inflation, the purchasing power of the money in the savings account actually decreases by 1% over the specified period.
Inflation-Adjusted Returns in stock investment
Consider a stock investment with an average annual return of 8%, while the inflation rate stands at 3%. By subtracting the inflation rate from the average return, we find the inflation-adjusted return (real return) to be approximately 5%. This means that after adjusting for inflation, the investor’s purchasing power increases by 5% annually.
Worried about the real value of your returns getting depleted with time? You can use this calculator to know how much you will need to invest with changing inflation and interest rates. Keep your financial plan updated.
INFLATION CALCULATOR https://mf.nipponindiaim.com/knowledge-center/tools/inflation-calculator
Final Takeaway | How to Calculate and Leverage Inflation-Adjusted Returns
This is important as it helps investors understand if they are gaining or losing wealth in real terms. By recognizing the impact of inflation on investment returns, you can safeguard your wealth against the erosive effects of rising prices, ultimately preserving and growing your purchasing power over time. Whether you’re a seasoned investor or just starting your financial journey, knowing How to Calculate and Leverage Inflation-Adjusted Returns will undoubtedly serve as a cornerstone for achieving financial success and security in the years to come.
Read also : The 4 M of Successful Investing https://thebrightdelights.com/the-4-m-of-successful-investing/