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 1understanding inflation adjusted returnthe 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 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 returncalculating 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 example of inflation adjusted returnassume an investor purchases a stock on january 1 of a given year for 75 000 at the end of the year on december 31 the investor sells the stock for 90 000 during the course of the year the investor received 2 500 in dividends at the beginning of the year the consumer price index cpi was at 700 on december 31 the cpi was at a level of 721 the first step is to calculate the investment s return using the following formula the second step is to calculate the level of inflation over the period using the following formula the third step is to geometrically back out the inflation amount using the following formula since inflation and returns compound it is necessary to use the formula in step three an investor who simply takes a linear estimate by subtracting 3 from 23 3 would arrive at an inflation adjusted return of 20 3 which in this example is 0 6 too high nominal return vs inflation adjusted returnusing inflation adjusted returns is often a good idea because they put things into a very real world perspective focusing on how investments are doing over the long term can often present a better picture when it comes to its past performance rather than a day to day weekly or even monthly glance but there may be a good reason why nominal returns work over those adjusted for inflation nominal returns are generated before any taxes investment fees or inflation since we live in a here and now world these nominal prices and returns are what we deal with immediately to move forward so most people will want to get an idea of how the high and low price of an investment is relative to its future prospects rather than its past performance in short how the price fared when adjusted for inflation five years ago won t necessarily matter when an investor buys it tomorrow 