What it is:
savings account pays 1.5% per but inflation is 3%, the saver is effectively losing every year he has the money in the account. However, putting money in a savings account is better than putting it in a coffee can in the backyard, where it lose the full 3% value every year due to inflation.eats away at the value of every stream of flows, including salaries, pension payments and payments. In many cases, the real interest rates on savings accounts are negative. For instance, if a
Accordingly, it is important to consider the effects of inflation when making an cash flows. After all, what is worth $1 today may not be worth $1 tomorrow if it is not invested.that promises to provide a future stream of
How it works (Example):
Let's say John Doe buys Company XYZ stock for $5. A year later, the stock is trading at $6. John's return is 20%. However, inflation during the year was 4%. Using this information and the formula above, John's inflation-adjusted return is:
[(1+.20)/(1+0.04)]-1 = 15.38%
John's return may look like it's 20%, but after you account for the fact that inflation has "eaten away" at that money, his inflation-adjusted return is only 15.38%.