A dollar is not always a dollar
Inflation is the general rise in prices over time. When prices rise, the same amount of money buys less: its purchasing power falls.
At a steady 3% a year:
| Years from now | What $100 of today's goods costs | What $100 buys (in today's terms) |
|---|---|---|
| 0 | $100 | $100 |
| 10 | $134 | $74 |
| 20 | $181 | $55 |
| 30 | $243 | $41 |
Inflation rates vary year to year and country to country; 3% is used here only as an illustration.
Nominal vs real
- Nominal return: how much a balance grows in raw numbers.
- Real return: how much its purchasing power grows, after inflation.
A quick approximation: real ≈ nominal − inflation. More precisely: (1 + nominal) ÷ (1 + inflation) − 1.
| Nominal growth | Inflation | Real return (approx.) | What happens |
|---|---|---|---|
| 5% | 3% | +1.9% | Buying power grows slowly |
| 3% | 3% | 0% | Buying power stays flat |
| 2% | 4% | −1.9% | Buying power shrinks |
This is why money held for many years in places that pay little or no interest can lose real value, even though the balance never goes down.