Nominal and real returns: what inflation changes
Use a hypothetical 100-unit example to distinguish purchasing power from the shortcut of subtracting percentages.
An account balance can rise while the quantity of goods it buys falls. A nominal return describes the change in money. A real return describes the change in purchasing power relative to a chosen price basket.
Define a comparable measurement
Use the same period and currency. A one-year account return cannot be compared directly with one month of inflation. A deposit into the account is not investment profit: account for cash flows separately first.
A consumer price index represents a defined basket and population. Your spending may differ. A general index does not automatically measure every individual’s personal inflation.
Work through the purchasing-power example
Suppose 100 currency units become 108 over one period: a nominal gain of 8%. A basket that cost 100 now costs 105: inflation is 5% in this example. The ending balance buys 108 / 105 = 1.028571 baskets instead of one.
The real gain is therefore about 2.8571%. Subtracting 5% from 8% gives a convenient approximation of 3 percentage points, not the exact purchasing-power gain. For nominal return r and inflation i over the same period, use (1 + r) / (1 + i) − 1, with percentages expressed as fractions.
Our own teaching example; all figures are hypothetical.
(1 + 0.08) / (1 + 0.05) − 1 = 0.028571… ≈ 2.8571%
| Measure | Start | End |
|---|---|---|
| Money | 100 | 108 |
| Price of the same basket | 100 | 105 |
| Baskets affordable | 1 | 1.028571 |
Record the inputs before interpreting the result
Record the currency, start and end dates, index and income components. Distinguish a security’s price change from a return that includes dividends. Fees and taxes can reduce the result; our simple calculation excludes them.
A price chart alone does not show the real purchasing power of all your capital. Before reviewing a market scenario, establish which prices and intervals the chart actually displays.
Money rises by 5%, while the chosen basket costs 8% more. Is purchasing power preserved?
No. 1.05 / 1.08 − 1 ≈ −2.7778%. There is more money, but it buys fewer identical baskets.
Sources
Sources checked: 2026-10-20
This material and its translations were prepared with AI assistance. Educational calculations were checked programmatically. Sources explain concepts; examples and files were created for this article.
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Continue with reading a market candle to distinguish a price move from the capital owner’s result.
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