Why Your Investment Returns Are Not What They Appear

Your portfolio went up 4% last year. Inflation ran at 5%. You lost money. Here is why the number on your screen tells only half the story.

Suppose you invested €10,000 at the start of the year. By December, it had grown to €10,400 — a 4% return. Most people would consider that a decent year.

Now suppose inflation ran at 5% over the same period. The €10,400 in your account can now buy less than your original €10,000 could a year ago. In real terms, you did not gain 4%. You lost approximately 1% of your purchasing power.

The number on the screen went up. Your actual wealth went down. This is one of the most important distinctions in investing, and one of the most consistently overlooked.

Why Your Investment Returns Are Not What They Appear // PEIID

What Inflation Actually Is

Inflation is the rate at which prices rise across the economy over time. When inflation runs at 3%, something that cost €100 last year costs €103 this year. Your money buys less than it did before.

This matters for investments because money has no fixed value. A euro today is not the same as a euro ten years ago. The euro ten years ago could buy more. Inflation is the mechanism by which money gradually loses purchasing power, and it operates continuously in the background of every financial decision you make.

In 2022, US inflation peaked above 8% — the highest level in four decades. At that rate, the purchasing power of cash loses roughly 8% in a single year. By 2025, inflation had fallen back to around 3.7%, still above the Federal Reserve’s 2% target but far less dramatic. The erosion continues regardless of the headline rate. It just moves at different speeds.

Nominal vs Real Returns

The return your investment shows on paper is called the nominal return. It is the raw percentage gain before any adjustment for inflation. The return that actually matters — the change in what your money can buy — is called the real return.

The relationship is straightforward. Real return equals nominal return minus inflation. If your portfolio gained 7% nominally and inflation was 3.7%, your real return was approximately 3.3%. If your portfolio gained 4% nominally and inflation was 5%, your real return was approximately minus 1%.

Current market data illustrates this clearly. The S&P 500 produced nominal returns of around 7% in the first half of 2025. After adjusting for inflation running at 3.7%, the real return was closer to 3.3%. Still positive, still meaningful, but a very different number from the headline figure.

For bonds the picture is tighter. A 10-year US Treasury bond yielding around 4.5% sounds reasonable in isolation. With inflation at 3.7%, the real yield is barely 0.8%. After tax, for many investors, the real return on a government bond is close to zero or negative.

The Problem with Cash

The gap between nominal and real returns is most damaging for cash held in low-interest savings accounts.

A savings account paying 1% interest sounds like it is at least doing something. But at 3.7% inflation, the real return is negative 2.7%. Every year the money sits there, it loses nearly 3% of its purchasing power. After five years at 3% inflation, €10,000 retains the buying power of roughly €8,600 in today’s terms. The account balance is higher. The real value is lower.

This is why holding large amounts of cash over long periods is not a neutral decision. It is a choice to accept a guaranteed real loss. Inflation does not require your permission to erode the value of money sitting in an account.

The Long-Term Compounding Effect

The gap between nominal and real returns compounds over time in ways that are difficult to intuit.

Consider two scenarios for a €10,000 investment held over 30 years. In the first, the investment grows at 7% nominally and inflation runs at 3%. At the end of 30 years, the account shows approximately €76,000. Adjusted for inflation, the real value is closer to €40,000. The nominal figure is almost double the real figure, and the gap widens with every passing year.

The implication is significant for anyone saving for retirement or a long-term goal. The number you need to reach is not the nominal figure your account will show. It is the purchasing power that figure represents at the time you need it. A retirement target calculated in today’s money needs to be adjusted upward for every year of inflation between now and retirement.

What Beats Inflation and What Does Not

Not all investments respond to inflation in the same way.

Equities, particularly shares in companies that can raise their prices as inflation rises, have historically produced real returns over long periods. The S&P 500’s long-run nominal return of around 10% per year, adjusted for historical inflation of roughly 3%, produces a long-run real return of approximately 7%. That is why broad equity index funds are the most commonly recommended vehicle for long-term wealth building: they have consistently beaten inflation over meaningful time horizons, unlike cash or low-yield bonds.

Real assets, such as property and commodities, tend to hold their value during inflationary periods because their prices rise alongside general prices. Gold is frequently cited as an inflation hedge, though its real-world performance over specific periods is inconsistent.

Fixed-rate bonds are the most vulnerable. When you lock in a fixed interest rate, and inflation subsequently rises above that rate, the purchasing power of your interest payments and eventual principal repayment falls in real terms. This is what happened to many bondholders during the 2021 to 2023 inflation surge.

Cash is the most predictably punished. Its nominal value is fixed and its real value falls at exactly the rate of inflation.

What This Means in Practice

The practical implication is not to stop tracking nominal returns but to stop treating them as the complete picture.

When assessing whether an investment is performing, the relevant question is not “did it go up?” but “did it go up by more than inflation?” A 3% return in a 2% inflation environment is a genuine real gain. The same 3% return in a 5% inflation environment is a real loss.

This reframing also changes how you think about the cost of not investing. Money sitting in a low-interest account is not safe. It is losing value at a known, predictable rate. The risk of doing nothing with cash is not zero — it is the rate of inflation.

Key Takeaways

Nominal return is the raw percentage gain your investment shows. Real return is what remains after subtracting inflation. Only the real return tells you whether your purchasing power actually increased.
With inflation at 3.7% in 2025, a nominal S&P 500 return of 7% produced a real return of around 3.3%. A savings account paying 1% produced a real return of negative 2.7%.
Cash held over long periods is not a neutral choice. It loses purchasing power at exactly the rate of inflation, year after year.
Equities have historically been the most reliable way to beat inflation over long time horizons, producing real returns of around 7% annually based on the S&P 500’s long-run record.
When setting long-term savings goals, the target should account for inflation between now and when the money is needed — not just the nominal figure required today.