Inflation-Adjusted Return

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Equation / Last modified by cjlynch on 2016/07/07 18:54
`"Real Return" = `
cjlynch.Inflation-Adjusted Return

The inflation-adjusted return is the measure of return that takes into account the time period's inflation rate. Inflation-adjusted return reveals the return on an investment after removing the effects of inflation. Removing the effects of inflation from the return of an investment allows the investor to see the true earning potential of the security without external economic forces.

This real rate of return may be used to compare investments, especially those across international borders, as each country's inflation rate is accounted for in the return. Without adjusting for inflation, an investor may get an entirely different picture from reality when analyzing an investment's performance. For example, assume a bond investment is reported to have earned 2% in the previous year. This looks like a gain, but perhaps inflation last year was 2.5%. Essentially, this means the investment did not keep up with inflation and effectively lost 0.5%.

As another example, assume a stock returned 12% last year and inflation was 3%. An approximate estimate of the real rate of return is 9%, or the 12% reported return less the inflation amount.