How to calculate inflation adjusted return over multiple years

Stocks
1

Hi,

I am struggling to find the formula that can help me calculate the Inflation-adjusted return over multiple years.

I came across the formula → (1+ return rate)/(1+ inflation rate) - 1 to get the real rate of return. Is it right to use this real rate of return per annum to calculate inflation-adjusted return? Can this formula be used for multiple years, or is it valid only for one year?

Also, using the real rate of return from the above formula, is it right to calculate yearly returns over a period of time?
Let me make it clear through an example:
Let’s say I have 100 rupees and expect to earn 12% p.a. over 20 years. And, let’s say that the inflation is 5% p.a.
Now, what is the right way to calculate inflation-adjusted return?

  1. I can get the final amount with 12% interest on 100 over 20 years first. Then, adjust for 5% inflation.
  2. Or, I can calculate the real rate of return using the above formula, and calculate the final amount with the real rate of return on 100 over 20 years.

Which way is the right one to calculate? Also, would be grateful if you could provide the exact formula to adjust for inflation.

Thank you so much,

2

The formula quoted above is true can be used for any number of years as long as the rate of return and inflation rate remains the same.
In case any one factor changes after ‘n’ number of years then the real rate of return will change hence you calculate the real returns you have accumulated till that date and then calculate for the remaning period with new real rate of return.

3

The real rate of return is factoring in the inflation for the current year also thats why the real rate you get for your example is 6.67 and not 7 which would be 12-5.
So Calculating return for 12 years and then deduction inflation is wrong.
2nd method is right.

4

Thank you so much Goutam! Really appreciate it.