Negative real returns: when a growing balance still loses money

An account paying 2% while inflation runs at 5% is losing 2.86% a year in real terms. The balance grows. The buying power shrinks. The plus sign on the statement is doing the lying: more euros, fewer things those euros can buy.

The exact arithmetic

The correct way to combine a nominal rate with inflation is to divide growth factors, not subtract percentages. A growth factor is just 1 plus the rate: 2% growth is a factor of 1.02, and 5% inflation is a factor of 1.05. Divide the money’s growth factor by inflation’s growth factor, subtract 1, and you have the real return: 1.02 divided by 1.05, minus 1, comes to -2.86%. That is the Fisher equation, and it is exact.

Run the same arithmetic the other way round and the picture flips. Money growing at 5% while inflation runs at 2% gives 1.05 divided by 1.02, minus 1, which is 2.94%. Same two numbers, swapped positions, and the saver goes from losing ground to gaining it.

Why the shortcut misleads

The common shortcut is to subtract: nominal minus inflation. For 2% against 5%, that gives -3%. For 5% against 2%, it gives 3%. Both are close to the exact answers of -2.86% and 2.94%, but neither is exact, and the gap is not always small enough to ignore.

Push the rates higher and the shortcut’s error grows with them. At 10% nominal against 8% inflation, the subtraction says 2%. The exact Fisher calculation says 1.85%. That is a meaningful drift for a rate this size, and it is the same pattern every time: the shortcut is a reasonable approximation at low rates and an increasingly unreliable one as rates rise, because it ignores the interaction between the two growth factors.

Where this bites

The gap between nominal and real matters most where the nominal figure is the only one anyone quotes. Cash savings accounts are the clearest case: a rate that looked adequate when it was set can turn negative in real terms the moment inflation rises, with no change to the account itself. Long-term products that guarantee a fixed nominal return decades out carry the same risk in slow motion — the guarantee is real, but what it guarantees to buy is not fixed at all.

None of this is a reason to avoid any particular account or product; it is a reason to ask what a quoted rate is actually promising. This is educational, not advice, and the right response to inflation risk depends on circumstances a professional adviser is better placed to weigh.

Try your own numbers

The shrinking side: 5% nominal against 2% inflation gives 2.94% real. 10% against 8% gives 1.85% real (the shortcut would say 2%). 2% against 5% gives -2.86% real.

Inflation’s effect on prices alone, starting from €100 today: at 2% a year, that €100 needs €121.90 in ten years, €148.59 in twenty, and €199.99 in thirty-five — roughly double, which is why 2% inflation is often described as doubling prices over about 35 years. At 5%, the same €100 needs €162.89 in ten years. At 10%, it needs €259.37.

The same effect in reverse, on money fixed in the future: €10,000 received in 30 years, deflated at 2% inflation, buys €5,520.71 of today’s purchasing power. €26,533 received in 20 years buys about €17,856 of today’s purchasing power at that same 2%. The nominal figure never changes; what it is worth does.