Introduction

An inflation-adjusted return is the actual return on your investment minus any effects of inflation. It is the best way to understand how much your money has increased in purchasing power. In India, inflation typically ranges from 5% to 7% per year, making it crucial to assess whether your investments, such as fixed deposits, mutual funds, or gold, are truly protected against rising costs. Nominal returns are helpful but may lead to deception when viewed alone.

What is the importance of inflation-adjusted returns to you?

Suppose you are earning 8% on a mutual fund, while India's CPI (Consumer Price Index) inflation is running at 6%. In that case, your investment has appeared profitable at first glance. It means inflation reduced the real value of your gains. Your purchasing power has grown, but not 8%. You might be able to purchase more as inflation increases, but probably not that much more. An inflation-adjusted return should let you know what your returns mean and prevent you from being deceived by nominal returns. This becomes critically important when investments are being compared across time or when doing so globally, and India has differing inflation rates from other economies. From 2024 to 2025, India's CPI inflation averaged around 5.5%, according to RBI data, so your nominal returns had to exceed the average CPI inflation to increase your wealth after inflation.

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How to Compute Inflation-Adjusted Returns

Computing inflation-adjusted return consists of a relatively simple process. The inflation-adjusted return formula will include the compounding costs so that you can be exact. Below are the three steps you will complete:

Determine Nominal Return: This is the total return on your investment before we account for inflation. It includes both price appreciation and dividends.

Formula: (ending value - beginning value + dividends) / beginning value.

Determine Inflation: The inflation-adjusted rate will use India's CPI-Combined.

Formula: (ending CPI - Beginning CPI) / Beginning CPI.

Adjust for Inflation: Lastly, you will use the geometric formula to obtain the real return.

Inflation-adjusted return formula: (1 + nominal return) / (1 + inflation) - 1.

Using this process, you can be sure you aren't overstating gains by adjusting for inflation without considering the compounding effect.

Example: Assume that on January 1, 2024, you invest Rs. 1,00,000 in an equity mutual fund. At the end of 2024, you end up with Rs. 1,15,000 and Rs. 2,000 in dividends. Now let's say the CPI in India went from 180 to 189.9, or about 5.5% inflation, as shown by recent monthly increases.

• Nominal Return (1,15,000 - 1,00,000 + 2,000) / 1,00,000 = 0.17 or 17%.

• Inflation Rate (189.9 - 180) / 180 = 0.055 or 5.5%.

• Inflation Adjusted Return (1 + 0.17) / (1 + 0.055) - 1 = 1.17 / 1.055 - 1 = 0.1085 or 10.85%.

If you remove inflation, your real rate of return is 10.85%, not 11.5%. This is precisely why the inflation-adjusted return formula is so important.

Why use Inflation-Adjusted Returns?

Focusing on inflation-adjusted returns makes it much clearer for you to evaluate the performance of your investment. For example, a fixed deposit that earns 6% may seem risk-free, but if inflation is 5.5%, your real return is just 0.5%, hardly keeping pace with rising prices. Equities and gold have typically produced higher nominal returns than fixed deposits over the years, even if that does not continue similarly. It also allows an investor to compare equities and fixed income investments worldwide (for example, comparing an Indian mutual fund to a stock in the USA) with those in India, earning greater real returns thanks to India's higher inflation.

Risks and Considerations

Inflation is not uniform across all your monthly CPI goods, services, or aspects. Combined with your personal expenses, for example, in India, due to typically rising faster than the generalised CPI, costs like housing, education, and healthcare affect real returns differently for each household. Taxes also diminish your real returns (for example, capital gains will be taxed). Real returns do not consider taxes; therefore, they should be factored in. During periods of higher inflation (as we have all seen post-2020), nominal returns may inflate this illusion, and it is crucial to value and monitor everything in real returns and performance with tools like Motilal Oswal's investment calculators.

Conclusion

When you know your inflation-adjusted returns, you can make sound decisions. Whether you are investing in stocks, mutual funds, bonds, or real estate, understanding your real returns means you are growing your wealth faster than inflation. At Motilal Oswal, we help investors analyse investments clearly and design strategies to maximise their real returns. Start calculating today and create a future where your money works harder than the inflation rate.

Similar reads: What is inflation and its causes? | Understanding Inflation and Its Pros and Cons