What does “adjusted for inflation” mean and how are they related to investment portfolios?
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Inflation effectively serves as a negative interest rate
If you invest $100 and get a 10% return in one year then you have $110 at the end. But inflation means those dollars buy less, if everything has increased in price by 15% then your $110 buys as much as $95.65 would have last year so your return rate *adjusted for inflation* is actually -4.35% which isn’t good. If inflation was only 5% then your real return was about 5%
Adjusting for inflation is important to know how much more value you end up with rather than how many more nominal dollars you have, and let’s you talk about everything in “today’s dollars”
Consider a real world example – Venezuela 2 year bonds are currently offering a yield of 92,571%, that’s crazy right?! And yes, that’s 92 *thousand percent*
Bad news, those bonds pay out in Bolivars not USD. Since Venezuela is currently undergoing hyperinflation the real return on these bonds (when you convert back to a stable currency) is going to be no more than about 5% but is currently predicted as -100% since you’ll probably never get paid
Nominally this rate looks insanely good, adjusted for inflation its insanely bad
Inflation is the (gradual) increase of prices (or decrease in value of currency) over time. $1 in 1970 has the same face value as $1 in 2020, but can’t buy the same amount. So any system that tracks money/value over time, like an investment portfolio, will account for this.
Saying “adjusted for inflation” means they are converting all the money deposited/earned over time to a single time point, so you can see how well your investments are doing without the effects of inflation.
Inflation is the value of a dollar getting lower with time. You always hear people talk about the time gas was a quarter a gallon, or how you could buy a pack of gum for a nickle. Well, because of inflation, now it costs $3.25 a gallon and a dollar for a pack of gum. There are more people, more companies generating more money. More money = the value of money goes down.
So when they adjust for inflation, it means they’re showing you all the numbers based on how much the dollar costs *today*, so that you have a direct, easy-to-read comparison.
For instance, say someone is saying “this cost $50 in 1950 and $300 in 2021”. If it’s *not* adjusted for inflation, then you might think that the value of the investment really went up quite a bit since 1950… But when you *do* account for inflation, you’ll see that that 1950’s $50 is actually worth $542.70 in 2021. So when you adjust for inflation, you see that investing in whatever that was in 1950 would have actually resulted in a *loss* of value, assuming you just bought $50 of whatever and never touched it again.
In order to get an idea of actual growth of an investment in regard to buying power, you need to determine how it did relative to inflation. If an investment goes up 10% annually for 10 years, that’s great if inflation was only 2%, but your buying power dropped if inflation was 20% during that time.
Let’s say you have $50k which would buy you a loaded BMW 3-series today… in 10 years will that still buy you a loaded 3-series, a stripped down Hyundai (not good), or a Rolls-Royce (good!)
Inflation is another name for simply printing more money, with nothing backing it up, thus devaluing it.
Currency was once backed by actual real gold. Now it’s backed by literally nothing and relies on trust alone.
Bread cost 25c xxx years ago.
Now it costs a dollar – why so?
Because the amount of dollars in circulation has quadrupled.
“Adjusting for inflation” means they’re printing money like confetti.
We should not simply accept INFLATION as normal as we’re led to believe.
We should be asking why DEFLATION isn’t the acceptable norm.
Inflation means you have to adjust the dollar value of everything, not just investments.
Note: this explanation is over-simplified.
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