Inflation and Real Returns: What Your Investments Are Really Worth

The number on your investment statement can be misleading. If your portfolio grows 7% in a year but prices rise 3%, you're not 7% better off — you can buy only about 4% more than before. Over decades, the gap between the number you see and what it can actually buy becomes enormous.

This guide explains how inflation erodes money, how to calculate real returns, why cash can quietly lose value, and how to plan in today's money.

What inflation does to money

Inflation is the general rise in prices over time. Each year it's a little modest — central banks in many countries aim for around 2% — but it compounds just like investment returns, only in reverse.

At 2.5% inflation:

• In 20 years, you'd need about $1,639 to buy what $1,000 buys today.
• Put the other way, $1,000 held as cash would buy only about $610 worth of today's goods.

At 3% inflation over 30 years, money loses well over half its buying power. That's the quiet cost of doing nothing.

Nominal vs real returns

• A nominal return is the headline growth figure — what your statement shows.
• A real return is what's left after inflation — the growth in what your money can buy.

The precise formula is:

Real return = (1 + nominal return) ÷ (1 + inflation) − 1

A 7% return with 2.5% inflation gives a real return of about 4.4%. A rough shortcut is simply to subtract inflation from the return, which works reasonably well when both numbers are small.

Cash vs investing, after inflation

Here's an illustration: $10,000 plus $300 a month for 20 years, with inflation at 2.5% a year. To keep everything comparable, the monthly amount is assumed to rise with inflation, so all figures are in today's money:

You'd pay in $82,000 in today's money in every case. Invested, it grows meaningfully in real terms. In a 3% savings account it only just stays ahead. Earning nothing, it loses about a quarter of its buying power.

Why cash can feel safe but isn't

Cash doesn't fall in value overnight the way shares can, so it feels safe. But whenever its interest rate is below inflation, it's guaranteed to lose buying power every year. That doesn't make cash bad — it's essential for emergencies and short-term goals — but it's a poor home for money meant to grow for decades.

Do investments beat inflation?

Over long periods, company earnings and share prices have historically grown faster than inflation, because companies can raise prices and grow over time. That's a major reason long-term investors hold stocks. But it hasn't held in every year or decade: there have been long stretches when stocks failed to keep up with rising prices.

Bonds can struggle more during high inflation, because their fixed payments lose value. Inflation-linked bonds exist to address this.

Planning in today's money

When you set a long-term goal — a retirement pot, a FIRE number, a house fund — think in today's money. A target of $1,000,000 in 30 years sounds large, but at 2.5% inflation it would buy roughly what $477,000 buys today.

Two ways to handle it:

1. Grow your target by inflation. The How Much to Invest Monthly calculator has a "my goal is in today's money" switch that does this for you.
2. Use real returns throughout. The FIRE Calculator and the Inflation-Adjusted Returns calculator work entirely in today's money, so every number stays meaningful.

How fees and inflation stack up

Fees come straight out of your real return. If your investments return 7%, inflation is 2.5% and you pay 1% in fees, your real return drops from about 4.4% to about 3.4% — almost a quarter of your real growth gone. That's why keeping costs low matters so much over long periods. See the real cost of ETF fees.

Choosing an inflation assumption

• 2% — close to many central banks' targets.
• 2.5–3% — a moderately cautious planning figure.
• 4% or more — a useful stress test, reflecting periods when inflation ran high.

Testing a range is better than relying on one number. The Inflation-Adjusted Returns calculator shows your plan across inflation rates from 1% to 7%.

What a future target is really worth

Long horizons magnify inflation more than most people expect. Here's what $1,000,000 received in the future would buy in today's money:

A million in 40 years, at 3.5% inflation, buys about a quarter of what a million buys today. That's why setting long-term goals in future money can leave you badly short — and why planning in today's money is safer.

How inflation affects different investments

Different assets respond to rising prices in different ways. Broadly:

No single asset is perfect protection in every period, which is one reason long-term investors diversify.

Your personal inflation rate

Official inflation figures measure the average price change of a typical basket of goods. Your own experience can differ:

• If you rent, housing costs may rise faster or slower than the average.
• If you spend a lot on travel, education or healthcare, those prices can move very differently from groceries.
• In retirement, spending patterns change again.

When planning, it can be worth using an inflation assumption a little above the official target, especially for spending that matters most to you.

The bottom line

Inflation quietly reduces what your money can buy, every year. Measure your progress in real returns, plan your goals in today's money, and remember that cash earning less than inflation is losing ground. For money with decades to grow, investments that have historically outpaced inflation are the main defence.