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
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