Inflation
Purchasing power decrease over time.
What does Inflation mean?
Inflation is the gradual increase in the general price level of goods and services over time. As inflation rises, each unit of currency buys fewer items — this is known as a decrease in purchasing power. Understanding inflation helps you plan for the future by showing how much more things will cost and how much less your current savings will be worth if they don't grow at or above the inflation rate.
How to calculate Inflation
The future cost is calculated with the formula: Future Amount = Current Amount x (1 + Inflation Rate / 100) ^ Years. Purchasing power is the reverse: Purchasing Power = Current Amount / (1 + Inflation Rate / 100) ^ Years. Total inflation is the cumulative percentage increase over the entire period: ((1 + Rate / 100) ^ Years - 1) x 100. For example, at 3% annual inflation over 10 years, something that costs $10,000 today would cost about $13,439, and today's $10,000 would only buy about $7,441 worth of goods in future dollars.
FAQ
In the United States, the long-term historical average inflation rate is roughly 3% per year. However, inflation varies significantly over time — it can drop below 1% during economic slowdowns or spike above 7-8% during periods of high demand or supply disruptions. Central banks like the Federal Reserve generally target around 2% annual inflation.
If your savings earn less interest than the inflation rate, your money loses purchasing power over time. For example, $10,000 sitting in a 1% savings account while inflation runs at 3% effectively loses about 2% of its real value each year. To preserve purchasing power, your investments need to earn returns that at least match inflation.
Nominal returns are the raw percentage gain on an investment before accounting for inflation. Real returns subtract inflation to show the actual increase in purchasing power. For example, if your investment earns 8% in a year with 3% inflation, your real return is approximately 5%. Real returns give a more accurate picture of wealth growth.
Yes, negative inflation is called deflation. During deflation, prices decrease and the purchasing power of money increases. While this sounds beneficial, sustained deflation can harm the economy by discouraging spending (people wait for lower prices) and increasing the real burden of debt. Deflation is relatively rare in modern economies.
Common strategies include investing in stocks (which historically outpace inflation), real estate, Treasury Inflation-Protected Securities (TIPS), commodities, and I Bonds. Diversifying across asset classes and maintaining investments with returns above the inflation rate are key to preserving and growing your purchasing power over time.
Related calculators
- Compound Interest— Growth of money with reinvested interest.
- CAGR— Average annual growth rate.
- ROI— Return relative to investment cost.
- Simple Interest— Interest calculated only on principal.