Nominal and real returns: how much do you earn after inflation?

Earning 5% in a year does not necessarily mean becoming 5% richer. If prices rise during the same period, part of the return is absorbed by money’s loss of purchasing power. This is the difference between nominal return and real return: the former measures how much capital grows in euros; the latter measures how much the amount that capital can actually buy increases.

The concept is simple but very important. An investment can generate a positive return and still leave the investor with purchasing power that is almost unchanged or even lower. Understanding how much you are really earning therefore requires looking not only at the investment’s return, but also at inflation over the same period.

What is nominal return?

Nominal return is the figure normally shown first. If we invest 10,000 euros and the capital is worth 10,500 euros after one year, the nominal return is 5%.

The calculation is:

From an accounting perspective, the capital has indeed increased by 500 euros. But this figure says nothing about what happened to prices in the meantime.

If the cost of goods and services remained stable, those 500 euros represent a real increase in purchasing power. If prices instead rose by 4%, almost the entire return was absorbed by inflation.

Nominal return therefore answers the question:

“How much has my capital, expressed in euros, increased?”

Real return answers a different question:

“How much has what I can actually buy with that capital increased?”

Inflation reduces the real value of money

Inflation measures the general increase in prices over time. When prices rise, the same amount of money buys fewer goods and services.

According to ISTAT’s final figures, in August 2026 the national consumer price index for the whole population rose by 3.3% compared with August 2025. The carry-over annual average inflation rate for 2026 was 2.9%.

This does not mean every individual product rose by 3.3%. Inflation is an average measure based on a basket of goods and services. Over the same period, some categories can rise much more, others less, and some can even fall.

The figure is nevertheless useful for understanding the overall effect on prices.

Suppose someone leaves 10,000 euros completely idle for a year during which prices rise by 3.3%. The balance will still show 10,000 euros, but that amount will no longer have the same purchasing power as a year earlier.

The approximate rule

For a quick estimate, the following relationship is often used:

If an investment returns 5% and inflation is 3%, the real return can be approximated as 2%.

This is a useful shortcut when percentages are relatively low, but it is not the mathematically exact calculation.

The correct formula is:

Suppose the nominal return is 5% and inflation is 3%.

The real return will be:

Not exactly 2%, although the difference is small.

When the percentages become higher, the distinction becomes more important.

An example with 10,000 euros

Imagine investing 10,000 euros and earning a nominal return of 5% after one year.

The final capital will be:

But suppose inflation was 3% over the same period.

To understand what the 10,500 euros are really worth in terms of initial purchasing power, we must divide them by the increase in the price level:

In real terms, therefore, the capital did not increase by 500 euros but by around 194 euros.

The nominal return was 5%, but the real return was only 1.94%.

It is precisely this difference that makes judging an investment exclusively by its nominal return of limited value.

A positive return can become negative in real terms

Now suppose an investment returns 2% while inflation reaches 4% over the same period.

With 10,000 euros, the nominal amount would be:

The account therefore shows a gain of 200 euros.

But the real return would be:

The capital has increased in nominal terms, but its purchasing power has fallen.

This situation is particularly important when discussing deposits, current accounts and very cautious investments. A product may guarantee preservation of nominal capital while failing to preserve its real value.

Leaving money idle also produces a real return

When money remains fully liquid, its nominal return may be close to zero. This does not mean its real return is also zero.

If the nominal return is 0% and inflation is 3%, the exact real return is:

In approximate terms, almost -3%.

It is therefore possible to lose purchasing power without ever seeing your current-account balance fall.

This is one reason why nominal safety and preservation of capital in real terms are not the same thing.

The effect becomes much clearer over the long term

Inflation does not act for just one year. Price increases also compound over time.

For simplicity, suppose inflation is 3% each year for twenty years. An item costing 10,000 euros today would theoretically come to cost:

This means that after twenty years, around 18,000 euros would be needed to buy what initially cost 10,000 euros.

Similarly, 10,000 euros left completely idle for twenty years would have purchasing power equivalent to just over 5,500 euros today.

This is why relatively moderate inflation can seem unimportant in the short term but have significant consequences over longer horizons.

Nominal and real returns in long-term investments

Imagine two theoretical investments. The first produces an average nominal annual return of 4%, the second 7%. Also assume average inflation of 2.5%.

The approximate real returns would be 1.5% and 4.5%, respectively.

The difference still looks similar to the nominal difference, but over the long term the effect of compounding makes real returns very important.

Capital can grow substantially in nominal terms while growing much less in terms of purchasing power.

That is why, when modelling pensions, investments or objectives decades away, it is important to specify whether figures are expressed in future nominal euros or in today’s euros, meaning adjusted for inflation.

A million in forty years is not worth a million today

This point is particularly useful when looking at long-term projections. Suppose an investment plan shows final capital of one million euros after forty years.

The number may look enormous, but assessing it properly requires asking what the price level will be in forty years.

With hypothetical average inflation of 2% per year, one million euros in forty years would have purchasing power equivalent to around:

With average inflation of 3%, the real value would fall to around:

This does not make reaching a nominal million pointless. It simply means that comparing a future amount with today’s prices creates a distorted impression.

Long-term projections should therefore always specify whether they use nominal or real values.

Personal inflation can differ from official inflation

There is another complication. The inflation rate calculated by ISTAT represents average price movements for a basket of goods and services. But everyone consumes a different basket.

A household spending a very high share of its income on energy, food and rent may experience a different change in its cost of living from a household allocating more income to services or goods whose prices are rising less.

In August 2026, for example, Italian headline inflation was 3.3%, but energy prices recorded much larger changes, while core inflation was only 1.5%.

This means that a real return calculated using the headline index is a very useful measure, but does not perfectly represent every household’s individual experience.

Headline inflation and perceived inflation

Someone may also perceive inflation as much higher than the official figure. This often happens because frequently purchased items, such as fuel or food, carry more psychological weight than expenses incurred less often.

ISTAT also publishes indicators for frequently purchased products, precisely because price trends can differ significantly between categories. In August 2026, prices of frequently purchased products rose by 4.3% year on year, above the headline index’s 3.3%.

This helps explain why an individual’s perception of inflation can differ from the national average without either necessarily being “wrong”.

Taxes also reduce the effective return

So far we have compared nominal return and inflation, but investors often face a third element: taxation.

Suppose an investment produces a gross return of 5%. If some of the gain is absorbed by taxes and costs, the net return actually available will be below 5%.

To assess the increase in purchasing power correctly, we should therefore start from the return net of costs and taxes and then adjust it for inflation.

Conceptually:

This final figure best describes the actual increase in the investor’s purchasing power.

Taxation naturally depends on the instrument used and the specific circumstances, so there is no single percentage applicable to every investment.

Costs may seem small but affect real returns

Imagine an investment with a gross return of 5%, total costs of 1.5% and inflation of 3%.

Simplifying and temporarily ignoring taxation, the nominal return after costs would be around 3.5%.

The approximate real return would therefore be just 0.5%.

A gross return of 5% may seem significant, but once inflation and expenses are considered, the real gain can shrink dramatically.

This is one reason why the costs of financial instruments are particularly important in long-term investing.

Be careful when comparing different periods

Another mistake is using an investment return relating to one period and inflation relating to another.

If an investment returned 7% between January and December, the comparison should use the price increase over the same period. Using inflation for the latest available month or an average over a different period can produce an inaccurate result.

The same applies when comparing historical returns over ten or twenty years: cumulative inflation over the entire interval must be considered.

Real return is always a relationship between two changes measured over the same time span.

Inflation can also be negative

Prices do not necessarily always rise. With deflation, meaning a general decline in the price level, money’s purchasing power can increase even without a positive nominal return.

If an investment returns 0% while prices fall by 2%, the real return becomes positive.

Deflation has other economic consequences, however, and should not automatically be considered desirable. It can be associated with weak demand and can increase the real burden of debts.

This nevertheless demonstrates that nominal and real returns are distinct concepts, and that the latter always depends on price movements.

The objective is not necessarily to “beat inflation” every year

It is often said that an investment should always beat inflation. As a long-term objective, this reasoning makes sense: if returns remain systematically below price increases, purchasing power falls.

But this does not mean every individual year must produce a positive real return.

An equity portfolio may lose 20% in a year even with inflation at 2%. The next year, it could recover much more. Assessing long-term investments by comparing returns and inflation for a single year can therefore be of limited value.

Cumulative returns and cumulative inflation must be compared over a horizon consistent with the investment’s objective.

Preserving nominal capital is not the same as preserving wealth

This is probably the most important implication.

If someone considers only assets that “cannot fall” to be safe, they may concentrate all their wealth in instruments that preserve nominal value perfectly. But if these consistently return less than inflation, nominal safety is achieved at the cost of a gradual real loss.

On the other hand, accepting greater risk solely to try to outpace inflation is not automatically the right decision. Riskier investments can produce negative returns even over substantial periods.

Wealth management therefore requires a balance between nominal protection, purchasing power, risk and time horizon.

A final example

Imagine three people, each with 20,000 euros.

The first holds the money with no return. The second earns a net return of 2%. The third earns a net return of 5%.

Assume inflation of 3%.

After one year, we would have:

All three people see an amount in their account equal to or greater than the initial figure. Yet only the third has actually increased their purchasing power.

That is the difference between simply looking at euros and looking at their economic value.

Conclusion

Nominal return tells us how much capital has grown in monetary terms. Real return tells us how much of that growth remains after accounting for price increases.

Confusing the two concepts can lead to substantial overestimation of investment results, especially over long periods.

An investment returning 5% with inflation at 3% does not actually produce a 5% increase in purchasing power. Money sitting idle in an account does not necessarily preserve its economic value. And a very large future sum can be worth much less than its nominal amount suggests if prices have risen for decades in the meantime.

To assess an investment properly, we should therefore ask:

“How much have I earned in euros?”

But immediately afterwards, also:

“After costs, taxes and inflation, how much has what I can buy actually increased?”

It is the second question that measures the actual growth in wealth.