Inflation and purchasing power
A bigger balance can buy less.
The number on a balance and what it can buy are different measures. Compare investment growth with changing prices using a fixed hypothetical basket.
Give the number a price date
A nominal balance is expressed in the money of its own date. A real balance translates it into the purchasing power of a chosen starting date. Inflation measures changes in a price level; the US Consumer Price Index tracks a representative consumer basket. It is a population measure, so an individual household with a different spending mix can experience different price changes.
Work through one year
Imagine $1,000 growing by 5% to $1,050. A basket that originally cost $1,000 now costs $1,030 after a hypothetical 3% price increase. Divide $1,050 by 1.03: the ending balance buys what about $1,019.42 bought at the start. The real gain is about 1.94%, even though the nominal gain is 5%. Neither percentage is a current inflation reading or an investment forecast.
Use a ratio, then compound
The exact one-period real return is (1 + nominal return) divided by (1 + inflation), minus 1, using decimal rates. Subtracting inflation from the nominal return is only an approximation. Over multiple years, divide the compounded balance by the compounded price change. With changing rates, multiply each period’s growth factors separately; do not substitute a simple average of the annual rates.
Recognize what the example leaves out
In the exercise, a constant 5% nominal return is held fixed so you can isolate prices. At 6% inflation the balance rises while purchasing power falls. The example excludes fees, taxes, withdrawals and contributions. It says nothing about which product to buy, and it does not mean cash has no role: access to money and exposure to loss are separate considerations from purchasing power.
Compare dollars with buying power
A hypothetical $1,000 grows at 5% a year for ten years. Change only the assumed annual inflation rate. These are invented constant rates, with no contributions, fees or taxes.
View values
- Nominal balance, year 10
- $1,628.89
- In starting-year dollars
- $1,212.05
- Real annual return
- 1.94%
At 3% inflation, the year-10 balance buys more than the starting $1,000: $1,212.05 in starting-year dollars.
Real value = nominal balance ÷ (1 + inflation rate) raised to the number of years. The chart table contains each annual value. Amounts round to cents.A balance grows 5% while prices rise 6%. What happens before fees and tax?
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Educational draft · Updated 11 October 2026 · Report a correction