Nominal vs real: the return that actually buys things

There are two numbers in every investment result and only one of them matters. The nominal return is what the statement says. The real return is what remains after inflation, and it is the only one that determines whether you can buy more than you could last year.

The exact relationship is (1 + nominal) ÷ (1 + inflation) − 1. Subtracting the rates works as a quick approximation, but it drifts once inflation is high. A 7% nominal return with 3% inflation is a 3.88% real return, not 4%. With 12% inflation, a 15% return is only 2.68% real.

This changes how deposits look. A fixed deposit at 7.1% sounds solid. Tax it at 30% and you keep 4.97%. Put 6% inflation next to that and the real return is negative one percent — the balance grows while the purchasing power shrinks. That is not a bad deposit; it is what cash does in an inflationary period.

It also changes how salaries look. A 5% raise in a 7% inflation year is a real pay cut of nearly two percent. Two such years in a row and you are meaningfully poorer despite two raises.

The practical discipline is to run every long-horizon plan twice: once in nominal money, to know what the account balance will read, and once in real money, to know what it will buy. If a retirement projection only exists in nominal form, it is almost certainly too optimistic.

Finally, decide the inflation number deliberately rather than by default. Your own basket — rent, school fees, medical cover — may be inflating well above the headline index, and planning with the headline figure quietly understates what you need.