# Inflation-Adjusted Return: Definition, Formula, and Example

## What Is the Inflation-Adjusted Return?

The inflation-adjusted return is the measure of return that takes into account the time period's inflation rate. The purpose of the inflation-adjusted return metric is to reveal the return on an investment after removing the effects of inflation.

Removing the effects of inflation from the return of an investment allows the investor to see the true earning potential of the security without external economic forces. The inflation-adjusted return is also known as the real rate of return or required rate of return adjusted for inflation.

### Key Takeaways

• The inflation-adjusted return accounts for the effect of inflation on an investment's performance over time.
• Also known as the real return, the inflation-adjusted return provides a more realistic comparison of an investment's performance.
• Inflation will lower the size of a positive return and increase the magnitude of a loss.

The inflation-adjusted return is useful for comparing investments, especially between different countries. That's because each country's inflation rate is accounted for in the return. 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 more realistic measure of an investment's return 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%).

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.

Inflation and returns compound, meaning if you don't use the correct formula and simply subtract the rate of inflation from the nominal return, the result you get won't be fully accurate.

## 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 and won’t reflect changing living costs for all.

## The Bottom Line

Inflation is part of life. Costs rise and erode, among other things, the value of investments. If your investment rose 12% in a given year but the cost of living went up 4%, then your actual return isn't going to be 12%. That’s why many investors look at the inflation-adjusted return. This measure takes the nominal return and deducts inflation to reveal the real return of an investment.

The inflation-adjusted return allows us to see the true earning potential of a security without external economic forces. And it can also be particularly useful when comparing investments between different countries, each of which will likely have different levels of inflation.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
1. Corporate Finance Institute. "RRR Adjusted for Inflation."

2. U.S. Bureau of Labor Statistics. “CPI Inflation Calculator.”

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