# Inflation-Adjusted Return: Definition, Calculation, and Examples

## What Is the Inflation-Adjusted Return?

Inflation-adjusted return measures investment performance by accounting for [inflation](https://www.investopedia.com/terms/i/inflation.asp) effects, revealing true earning potential. It provides a realistic look at gains or losses, unaffected by external economic factors, essential for comparing domestic and international investments.

Adjusting for inflation helps investors understand an investment's real [earning potential](https://www.investopedia.com/terms/e/earning-potential.asp) without outside economic influences. The inflation-adjusted return is also known as the real rate of return or required rate of return adjusted for inflation.

### Key Takeaways

*   Inflation-adjusted returns reveal the real return on an investment by accounting for inflation, providing a clearer picture of its earning potential.  
    
*   Calculating the inflation-adjusted return requires measuring the nominal return, the inflation rate, and then removing the inflation effects geometrically.  
    
*   Understanding the difference between nominal and inflation-adjusted returns helps investors assess the true performance of investments.  
    
*   Inflation-adjusted returns are especially useful when comparing investments across different countries with varying inflation rates.

## Why Inflation-Adjusted Returns Matter

The inflation-adjusted return is useful for comparing investments, especially between different countries. This is because the return reflects each country's inflation rate.  In this scenario, without adjusting for inflation across international borders, an investor may get vastly different results when analyzing an investment's performance. The inflation-adjusted return [serves as a realistic measure of an investment's return](https://www.investopedia.com/terms/i/inflation-accounting.asp) when compared to other investments.

For example, assume a bond investment is reported to have earned 2% in the previous year. This appears like a gain. However, suppose that inflation last year was 2.5%. Essentially, this means the investment did not keep up with inflation, and it effectively lost 0.5%.

Assume also a stock that returned 12% last year when inflation was running at 3%. An approximate estimate of the real rate of return is 9%, or the 12% reported return less the inflation amount (3%).

## How to Calculate Inflation-Adjusted Returns

![Image](https://www.investopedia.com/thmb/Nue4d1uPrxYYT77Fi-DK_giJ1Uw=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/dotdash_Final_Inflation_Adjusted_Return_Nov_2020-01-c53e0ae26e8f404fb1ce91a9127cbd3b.jpg)

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Calculating the inflation-adjusted return requires three basic steps. First, the return on the investment must be calculated. Second, the inflation for the period must be calculated. And third, the inflation amount must be geometrically backed out of the investment's return.

> **Important**
>
> Inflation and returns compound, so subtracting inflation from a nominal return may not give an accurate result. 

## Example of Inflation-Adjusted Return

Assume an investor purchases a stock on Jan. 1 of a given year for $75,000. At the end of the year, on Dec. 31, the investor sells the stock for $90,000. During the course of the year, the investor received $2,500 in dividends. At the beginning of the year, the [Consumer Price Index](https://www.investopedia.com/terms/c/consumerpriceindex.asp) (CPI) was at 700. On Dec. 31, the CPI was at a level of 721.

The first step is to calculate the investment's return using the following formula:

*   Return = (Ending price - Beginning price + Dividends) / (Beginning price) = ($90,000 - $75,000 + $2,500) / $75,000 = 23.3% percent.

The second step is to calculate the level of inflation over the period using the following formula:

*   Inflation = (Ending CPI level - Beginning CPI level) / Beginning CPI level = (721 - 700) / 700 = 3 percent

The third step is to geometrically back out the inflation amount using the following formula:

*   Inflation-adjusted return = (1 + Stock Return) / (1 + Inflation) - 1 = (1.233 / 1.03) - 1 = 19.7 percent

Since inflation and returns compound, it is necessary to use the formula in step three. An investor who simply takes a linear estimate by subtracting 3% from 23.3%, would arrive at an inflation-adjusted return of 20.3%, which in this example is 0.6% too high.

## Comparing Nominal and Inflation-Adjusted Returns

Inflation-adjusted returns are useful because they provide a realistic view. Focusing on how investments are doing over the long term can often present a better picture when it comes to its past performance (rather than a day-to-day, weekly, or even monthly glance).

But there may be a good reason why nominal returns work over those adjusted for inflation. [Nominal returns](https://www.investopedia.com/terms/n/nominal-rate-of-return.asp) are generated before any taxes, [investment fees](https://www.investopedia.com/articles/basics/11/investors-fees-cheat-sheet.asp), or inflation. Since we live in a “here and now” world, these nominal prices and returns are what we deal with immediately to move forward. So, most people will want to get an idea of how the high and low price of an investment is—relative to its future prospects—rather than its past performance. In short, past inflation-adjusted prices may not matter for future investment decisions.   

## What Is an Example of Inflation Adjustment?

Inflation adjustment means removing the effect of price inflation from data. For example, if a stock rose 23% in a year that inflation was running at 3%, we could conclude, more or less, that the actual return, accounting for the increased cost of living, was about 20%. 

## Why Is Inflation Adjustment Important?

Prices rise and that affects purchasing power. For example, $50 in April 2013 has the same buying power as $65.23 in April 2023. The same applies to money invested. A return on a $5,000 investment may be advertised as 70% over the course of 10 years. However, in reality, if you account for inflation, the actual return, or profit you make, is lower.

## What’s the Best Measure of Inflation?

In the U.S., the Consumer Price Index (CPI), which is produced by the Bureau of Labor Statistics (BLS), is the most widely used measure of inflation. It influences government policy and the cost of borrowing money. However, like other measures, it [isn’t perfect](https://www.investopedia.com/ask/answers/012915/what-are-some-limitations-consumer-price-index-cpi.asp) and won’t reflect changing living costs for all. 

## The Bottom Line

Inflation can significantly erode the apparent gains from your investments. For example, a 12% investment return during a year with 4% inflation results in a real return that's substantially lower than the nominal figure suggests. The inflation-adjusted return, or real return, provides a more accurate picture by accounting for inflation, allowing you to evaluate the true earning potential of your investments. This adjustment is crucial for accurately comparing performance across different economic environments, such as investments in countries with varying inflation rates.  

> **Article Sources**
>
> 1.  Corporate Finance Institute. "[RRR Adjusted for Inflation](https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/rrr-adjusted-for-inflation/)."
>     
> 2.  U.S. Bureau of Labor Statistics. “[CPI Inflation Calculator](https://www.bls.gov/data/inflation_calculator.htm).”