Do you want to know how to calculate the future value of money with inflation in MS Excel? Want to calculate inflation-adjusted return from your investment?
You’re in the right place.
Before going into the calculations, I will introduce you to several terms like:
- Future value
- Nominal Interest Rate
- Real Rate of Return
What is Inflation and how it affects our lives?
The prices of things go up and this is called inflation. Deflation is the antonym of inflation. The prices of things go down in the deflation period.
In the following image, we are seeing the inflation and deflation picture of the USA for the last around 100 years.
From the year 1920 to 1940 (20 years), deflation occurred more than inflation. From there, inflation dominated. So, most of the time, we see the prices of things are going up.
Suppose, you have $100 cash today. And the projected inflation for the next 1 year is 4%. If you still hold the cash ($100), after 1 year, your purchase power will be lower ($96) with that $100 cash.
If we see the general pricing of things, the $100 product will be priced now at $104. So, with your holding of $100 cash, you cannot buy the same product after 1 year that you could buy 1 year before.
So, inflation devalues the cash and increases the price of the product.
This is why holding cash is a bad idea in the investment world.
Future Value of Money
The future value of money can be thought of in two ways:
- The future purchase power of your money. With inflation, the same amount of money will lose its value in the future.
- Return of your money when compounded with annual percentage return. If you invest your money with a fixed annual return, we can calculate the future value of your money with this formula: FV = PV(1+r)^n. Here, FV is the future value, PV is the present value, r is the annual return, and n is the number of years. If you deposit a small amount of money every month, your future value can be calculated using Excel’s FV function. We shall discuss both methods in this tutorial.
Nominal Interest Rate
If you deposit your money with a bank, the bank provides you interest in your deposits. The rate, the bank provides your interest is called the Nominal Interest Rate. For example, if your bank provides 6% per year, then the nominal interest rate is 6%.
Real Rate of Return
You can use this simplified formula to calculate the real rate of return:
Nominal Interest Rate – Inflation Rate = Real Rate of Return
To get a Real Rate of Return, you have to deduct the Inflation Rate from the Nominal Interest Rate (or your yearly return).
But the accurate formula is shown below:
Let me explain this concept with an example. Suppose, you have invested $1000 in the money market and a got 5% return from there. The inflation rate is 3% for this period.
So, your total money is now: $1000 + $1000 x 5% = $1050.
But do your purchase power the same as before? Say, you could buy a product for $1000, now its price is $1030 (with 3% inflation).
How many of these products you can buy today?
$1050/$1030 = 1.019417476.
So, your REAL purchase power has increased from 1 to 1.019417476.
In % it is: ((1.019417476 – 1)/1)*100% = 0.019417476*100% = 1.9417%
We can reach this percentage also using this formula:
(1.05/1.03)-1 = 1.019417 – 1 = 0.019417 * 100% = 1.9417%
Download Excel File
Download the Excel file that I have used to write this article.
Calculate future value with inflation in Excel (Two Examples)
We shall calculate the future value with inflation in more than one way:
Example 1: Start with an initial investment and no recurring deposits
You have some investible money and you want to invest the money with the following details:
- Investible money: $10,000
- Annual return from investment (fixed): 8.5% per year
- Inflation rate (approx.) over the investment time: 3.5%
- Investment period: 10 years
- What will be your inflation-adjusted return?
This is the return you will get (following image).
Don’t misunderstand one thing. In real life, you will get actually return of the amount of $22,609.83 with the following formula (inflation is zero):
But the purchasing power of your value will be: $16,288.95
You will also come out with the same value if you use the following universal formula. For the value of r, you will use the real rate of return (real rate of return = annual return – inflation rate).
Read this article to learn more about how to use the above formula: Compound interest excel formula with regular deposits
Example 2: Start with an initial investment and make regular deposits
In this example, I am showing a scenario with the following details:
- Your initial investment: $50,000
- You’re paying a regular monthly deposit: $2500
- Interest rate (yearly): 8.5%
- Inflation rate (yearly): 3%
- Payment Frequency/Year: 12
- Total Time (Years): 10
- Payment per Period, pmt: $2,500.00
- Present Value, PV: 50000
- Payment is done at the beginning of the period
The following image shows the output.
Observe that in cell C7, we have calculated the Interest per Period by subtracting the Yearly Inflation Rate from the Yearly Interest Rate and then divided the value by the Number of Payments per Year.
What if the Yearly Return is lower than the Inflation Rate?
See this image. When the annual return is lower than the inflation rate, you will actually lose money.
Calculating the future value of your investment is important. But if you are calculating it without considering the Inflation Rate, you’re neglecting a very important thing. If you earn 8% annually from your investment in an economy where the inflation rate is 10%, you’re actually losing the value of your money.