Compound interest guide
Compound Interest vs Inflation: Nominal and Real Growth
Understand why a growing account balance can still lose purchasing power, and how to think about real returns.
Try this scenario
Open the calculator with this guide's example already filled in, then adjust the monthly contribution, return, or timeline to compare your own scenario.
Open calculator exampleKey Takeaways
- Nominal growth is the account balance before adjusting for inflation.
- Real growth is purchasing power after inflation.
- Long-term plans should compare expected returns with expected inflation.
Example Scenarios
| Scenario | Principal | Monthly | Return | Years | Result |
|---|---|---|---|---|---|
| Nominal 7% return | $100,000 | $0 | 7% | 30 | $761,226 nominal balance |
| Approximate 4% real return | $100,000 | $0 | 4% | 30 | $324,340 inflation-adjusted proxy |
Nominal dollars are not the whole story
Compound interest can make an account balance grow dramatically, but future dollars may buy less than current dollars. Inflation is the reason. A balance of $500,000 in 30 years is not the same as $500,000 of purchasing power today.
This does not make compound growth less useful. It means long-term planning should focus on real returns, which are returns after inflation.
A simple way to estimate real return
A practical approximation is nominal return minus inflation. If a portfolio earns 7% and inflation averages 3%, the real return is roughly 4%. The exact formula is slightly different, but the approximation is good enough for quick planning.
Using the calculator at 7% shows the nominal path. Using the same principal at 4% gives a rough purchasing-power comparison.
Why the gap becomes large
Inflation compounds too. A 3% annual inflation rate sounds small in one year. Over 30 years, it can cut purchasing power by more than half. This is why cash that looks safe can still lose real value over long periods.
Investors often seek assets that have a reasonable chance of outpacing inflation, while accepting that higher expected return usually comes with higher volatility.
How to use this in planning
Run two scenarios. First, calculate the nominal balance using your expected return. Second, calculate an inflation-adjusted proxy by lowering the return field by your inflation assumption.
If the real number is too low for your goal, you may need a longer timeline, higher contribution rate, lower costs, or a different asset mix.
Questions
Does this calculator directly adjust for inflation?
The current calculator models nominal compound growth. You can approximate real growth by subtracting expected inflation from the return input.
Is inflation always 3%?
No. Inflation changes over time. Use 3% only as a simple long-term planning assumption, then test higher and lower values.