Also called: Inflation-adjusted return, Real vs nominal.
Long-horizon planning done in nominal terms is close to meaningless, because the numbers stop describing anything you can buy. A projection that ends at $3 million in forty years sounds substantial until you notice that at 3% inflation it buys what about $920,000 buys today.
The habit worth building is to model in real terms throughout: real returns, real contributions, real spending. Every figure then stays in today’s money and can be compared directly with what you spend now.
The exact conversion is multiplicative rather than a subtraction — (1 + nominal) ÷ (1 + inflation) − 1 — though subtracting is close enough at low rates. It stops being close enough when inflation is high, which is exactly when the distinction matters most.
Fixed nominal amounts are the trap. A pension or annuity that pays a level amount for life loses roughly a third of its purchasing power over twenty years at 2% inflation, and about half at 3.5%.
Research on this
See also
- Expense ratio — The annual percentage a fund charges against assets to cover its own running costs, deducted from the fund’s value rather than billed to you.
- Safe withdrawal rate — The share of a portfolio’s starting value you can withdraw in year one of retirement, then raise with inflation each year, without running out over your horizon.
- Volatility drag — The gap between the average of a series of returns and the compound growth actually achieved. Higher volatility widens the gap, even with an unchanged average.