Real Return and Inflation, explained.
Real return measures the change in purchasing power after accounting for inflation. A larger nominal balance can still purchase fewer goods when their prices rise faster.
Why it happens
Nominal growth changes the account; inflation changes the price of the basket. Dividing the account growth factor by the price growth factor gives the real growth factor. Subtracting inflation from nominal return is only an approximation.
Real return measures the change in purchasing power after inflation. The exact one-period relationship is (1+nominal return)/(1+inflation)−1.
Read the result
Advance years and watch the basket price as well as the account. The More money, fewer baskets preset shows why both numbers are needed. Changing rates recomputes the chosen constant-rate scenario from the starting year.
A worked example
A growing account facing faster prices
Start with 100 tokens and a ten-token basket, so ten baskets are affordable.
After one year of 5% nominal growth and 8% inflation, the account is 105 and each basket costs 10.80.
You can buy about 9.72 baskets. The exact real return is 1.05/1.08−1, about −2.78%, despite the higher nominal balance.
OPTIONAL DEEPER DETAILGo deeper: inside the model
Inside this model
A 100-token balance and a 10-token basket evolve for ten years at constant chosen rates. Nominal wealth, basket price, and baskets affordable are computed separately. The exact real rate is compared with the subtraction approximation.
Where this idea is useful
A practical use
At 5% nominal growth and 8% inflation, the balance rises while its purchasing power falls.
A common misconception
“A positive nominal return always preserves purchasing power.”
Purchasing power depends on the relevant price changes too. Taxes and personal consumption patterns can make an individual's real outcome differ from a broad index.
What this explanation leaves out
- The basket and constant rates are synthetic. Actual personal inflation can differ from an index; taxes, changing consumption, and investment risk are omitted.
Why show an original basket instead of a general inflation forecast?
A fixed teaching basket makes the denominator explicit. Its price changes are chosen assumptions and do not represent your expenses or a predicted national inflation rate.
When you compare future income with today's expenses, are both expressed in the same purchasing-power terms?
Associated thinkers
Associations marked provisional are awaiting source review.
Further reading
Explore the original research or the teaching reference behind this experiment.