Nominal and real returns
The number on the statement and the number that matters are different, and the gap is inflation.
A nominal return is the change in the number of currency units you hold. A real return is the change in what those units buy. Only the second one determines whether you are better off.
The arithmetic
Earn 4% in a year when prices rose 3% and your real return is roughly 1%. The exact calculation divides rather than subtracts, but at ordinary rates the difference is small enough that the subtraction is a fair working method.
It follows that cash earning less than the inflation rate is losing purchasing power while its balance rises. The statement shows a larger number every year and buys less every year, and both are true simultaneously.
Why this is the most under-used idea in personal finance
Because every figure you are shown is nominal. Account balances, historical returns, salary increases, house prices — all quoted in currency, none adjusted. Converting to real terms is a step you have to take yourself, and it changes conclusions more often than people expect.
- A pay rise below inflation is a pay cut. See how that looked in the year to August 2026 in our coverage of wages against prices.
- A house that doubled over twenty years may have barely kept pace, depending on the period.
- A “safe” cash holding carries a guaranteed real loss whenever rates sit below inflation.
What earns a real return
Assets whose cash flows can rise with prices have a mechanism for keeping up — businesses can raise prices, rents can be reset, inflation-linked bonds adjust by design. A fixed payment has no such mechanism, which is why long-dated fixed income suffers most when inflation surprises upwards.
If money held its value, keeping it safe would be a complete strategy. It does not, so leaving everything in cash is itself an active decision with a predictable cost — which is a different statement from saying any particular investment is wise.