Formula No. 4: Calculate inflation-adjusted return
You know that investments have to do more than keep pace with inflation for you to build wealth. As Golden says, "A dollar today is not worth a dollar in the future." But how do you determine what your investment return is after inflation?
This equation helps you compute your real return, or your return adjusted for inflation. For example, if an investment returns 8 percent, and inflation is 3 percent, this is how you'd set up the problem:
[(1.08 ÷ 1.03) – 1] x 100 = 4.85 percent real return
"You're losing to inflation every year," says Charles Sachs, a wealth manager at Private Wealth Counsel in Miami. "Long term, inflation runs about 3 percent. So your money buys half as much in 20 years."
In other words, leaving your money stuffed under your mattress creates a real risk that you'll have significantly less purchasing power than if you had invested it.Calculating your real return helps you figure out what your future purchasing power is likely to be.