Inflation-Adjusted Return

Inflation-adjusted return is the gain recorded for an investor after adjusting the amount for inflation. The inflation rate considered is for a set period. It is an important financial metric for unraveling the true return on an investment. It also helps ensure that an investor’s financial goals are not affected by inflation.

When investors calculate the inflation-adjusted return on any investment, it helps them derive the true gaining potential from the investment, given the ability to assess the accurate effect of inflation on any investment made. Also known as the real rate of return, this metric poses a more realistic scenario of an investment’s future performance, identifying the possible impact that inflation rates could have on it.

Inflation-adjusted return is the value of a profit or investment gain after accounting for inflation that exists and changes over time. Though every trader, investor, or market participant in the financial market has one goal in common, which is to make maximum profit, the existing and rising inflation rate makes it difficult to achieve this goal.

The world economy, political systems, social lives, and even financial markets and businesses are affected by inflation, and this makes it essential to consider it as a significant factor while deducing the return on investment. The main components for calculating the adjusted returns for inflation include nominal return, which is the increase in value of an investment without inflation, and the inflation rate, which is to be deduced by using different sources of inflation data, such as Cost Price Index (CPI), to determine the real rate of return further.

When investors calculate the inflation-adjusted return, they get to know the real profit they shall have or possess as, with time, the purchasing power of money declines. The markets become more expensive compared to the time when they invested. Hence, at the initial stages, every investment can appear profitable, but as the inflation rate is considered, the scenario changes. 

There is a significant possibility that after a certain period, the profit would be negligible or no difference, given the inflation, which is the general increase in the price of goods and services. But then, the investor did make a profit, but due to inflation, the gain has lost its purchasing power.

The equation below shows how the online inflation-adjusted return calculator works:

Inflation-adjusted return = (1+Return) ÷  (1+Inflation Rate) - 1

To determine the inflation-adjusted return of any investment, the basic rate of return and inflation rate over time must first be known or calculated.

Return = (Ending price - Beginning price + Dividends) ÷ (Beginning price)

Inflation rate = (Current year’s consumer price index - Previous year’s consumer price index) ÷ Previous year’s consumer price index

Here are two distinct examples of inflation-adjusted returns -

Example #1 

Suppose Evelyn is an investor. She invested in a hotel stock. She bought 100 shares at the price of $45 in 2024 and sold them at the price of $63 in 2025. During this time, Evelyn also received a dividend of $360.

Return = (Ending price - Beginning price + Dividends) ÷ (Beginning price)

First, to calculate the return, imply all the values in the return’s equation, therefore

Return = (63x100 - 45x100 + 360) ÷  (45x100) = 0.48

Return = 0.48 x 100 = 48%

For inflation rate, let us suppose that 2024’s CPI was 729 and 2025’s CPI was 756

Therefore, inflation rate = Current CPI - Previous CPI ÷ Previous CPI

Adding values to the formula,

(756 - 729) ÷ 729 = 3.7%

Evelyn was interested in deducing the inflation-adjusted return.

Now, inflation adjusted return = (1 + Return) ÷ (1 + Inflation Rate) - 1

Putting the values in the equation,

(1 + 48%) ÷ (1 + 3.7%) - 1

(1.48 ÷ 1.037) - 1 = 42.71%

Here, it is well observed that before accounting for inflation, Evelyn had a return of 48%, but after adjusting for inflation, the actual return Evelyn actually received is 42.71%

Example #2

In December 2023, Godman Sachs conducted research that discussed how the 60/40 portfolio was a better choice for investors during the period. In addition to describing the fruitfulness of such portfolios, the research report also emphasized the diminishing inflation rates, which are making bond yields quite higher than those recorded in 2022. It proved how the controlled inflation rate has stabilized the returns adjusted for inflation and has become one of the best ways of remaining protected from financial shocks if any arise.

The importance of inflation-adjusted return is -

• Inflation-adjusted return helps in comparing the basic rate or return to a rate of return that is adjusted for inflation.
• It enables an investor to make better investment decisions and choose an investment wisely after understanding the true return it will pay over time.
• Such returns serve as an important financial metric in stock markets and other financial markets when it comes to deriving the true value of an investment.
• Inflation is a worldwide phenomenon, and this metric accounts for it, which is essential from a financial perspective.
• Without inflation-adjusted return, investors can fall into investing pitfalls, make a loss, or miss out on another investment opportunity because they didn’t calculate it.

The critical differences between inflation-adjusted return and nominal return are -

• Nominal return is the percentage increase in an investment without accounting for inflation. In comparison, inflation-adjusted return is nominal return after adjusting for inflation.
• Nominal return offers a point of view of growing maximum returns, but inflation-adjusted return derives the true value of return based on purchasing power.
• Nominal return informs on how well the stock performed and gained profit. In contrast, inflation-adjusted return reflects the true value of a return by accounting for inflation.