In plain words
A growing balance does not always mean your money can buy more. Your real return is what remains after comparing your return with rising prices. It is like filling a bucket while a hole lets water out: the balance grows, but buying power can still fall. The mix-up is ignoring inflation, so a bigger balance may buy less.
You meet this idea when a savings account balance grows but everyday prices rise too. It also appears when comparing a deposit’s return with the changing cost of things you buy.
Two worked examples
The common mistake
The mistake: Seeing a balance grow and assuming the money is worth more, without allowing for how fast prices rose.
What’s true: Your real return is what is left after inflation: (1 + return) ÷ (1 + inflation) − 1, roughly the return minus inflation. Below zero, your money buys less each year, however the balance grows.
A raise below inflation is a pay cut
What pay buys matters, not its number. A raise is measured against how fast prices rose: real raise = (1 + raise) ÷ (1 + inflation) − 1. If prices rose faster than your pay, the same shopping takes a bigger share of it — the number went up, the pay went down.
A raise can still be a pay cut if prices rise faster than your pay. It is like getting a bigger basket that holds less shopping. The common mix-up is judging the raise alone; that misses how much prices rose at the same time.
You meet this idea when your employer offers a pay rise while shop prices are changing. It also appears when you review a salary against the cost of everyday shopping.
Where you’ll meet it
- Cash loses to inflationPrices climbing while cash sits still is a pay cut nobody announces.
- A yearly fee compounds against youEach year's fee also removes the growth that money would have earned in every year after.
- Inflation has a Rule of 72 tooThe doubling maths runs in reverse on idle cash — same rule, working against you.
Related terms
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