How do you compare profits to loss due to inflation?
August 21, 2014 11:20 AM Subscribe
I'm trying to compare the compounded losses due to inflation to non-compounded profits. E.g. if inflation makes me lose 3% of an investment each year, what % would I need to profit each year in order to exactly keep up? This is tricky because the profit is not compounded the way inflation is. I'm not looking for an answer to this specific question, but rather, looking for a tool or method to do this kind of math.
posted by brenton to Work & Money (12 answers total) 2 users marked this as a favorite
Ok, that's convoluted, so here's an example.
Say I can spend $100 to build a machine that prints $3 per year. In other words, it returns 3% of the initial investment each year.
Assuming inflation stays at 3%, how do I compare profits to inflation loss? Initially I thought that 3% gain would match up exactly with inflation each year, since your money would lose $3 of value (due to inflation) but you'd print $3.
But then I realized you'd lose less than $3 of value after the first year, since the inflation works on money that's already lost value. In other words, it compounds, so you would lose a little less than $3 of value the second year, and even less the next year. So then I figured that printing the $3 would put you above inflation.
But then I realize that the $3 you print is subject to inflation as well. It loses $0.03 of value, so you're not adding $3 per year, you're adding $2.91, which means the first year your value would go down from $100 to $99.91. So then I thought that you would be doing worse than inflation.
The more I think of this, the more confused I get. How do I do this math??
Obviously, this isn't a realistic scenario. A more real scenario, I'd be selling something, and the sale price would go up as inflation went up, so it would be easier to match inflation. But I can't even figure this out in a vacuum, I don't know how I'm going to figure it out with the added complexity of being realistic.