What Is Inflation?

Michael Whitman · Trading since 2017, full-time since 2020 · YouTube creator, 137K subscribers · Published 2026-09-14 · Updated 2026-10-03

Every other cost in finance is charged to you. This one is charged to the ruler you measure with, which is why an account can grow every single year and still be worth less at the end.

How it works

Prices rising and money weakening are the same event described from two sides. If a basket of goods costs 3% more this year, then the dollar in your hand buys 3% less. Nothing was taken from the account — the thing the account is denominated in got smaller.

So there are two versions of every return. The nominal one is what the statement says. The real one is what is left after inflation, and it is the only one that describes whether you can buy more than you could before.

Every long-run chart you have ever seen is nominal unless it says otherwise. A line rising steadily over thirty years is partly the asset doing well and partly the unit shrinking, and the two are not separated for you.

A worked example

Inflation is a fee, and it can be priced like one. A 3% inflation rate applied to cash is arithmetically identical to a fund charging 300 basis points a year — deducted annually, compounding, charged whether or not anything went well.

Put that next to the arithmetic of ordinary fund charges. Over thirty years, an annual charge of 5 basis points costs 1.5% of the final balance, 20 basis points costs 5.8%, 75 costs 20.2%, and 150 costs 36.5%.

Inflation at 3% is double the largest of those. No retail fund in the world charges 300 basis points, and the cost of holding cash through ordinary inflation exceeds it — silently, with no statement, and with no line item anyone can point to.

That is why cash is not the neutral position it feels like. It is the one asset whose nominal value cannot fall and whose real value falls every year by exactly the inflation rate. The safety is in the number, not in what the number buys.

And it compounds. Three percent for one year is a rounding error. Three percent for thirty years leaves purchasing power at about 41% of where it started — the money did not move and well over half of it is gone.

And the compounding runs against a target that is also moving. A savings goal stated as a fixed sum is quietly a smaller goal every year it is not met. Stating it in today’s money and revising it upward with prices is the only version that means the same thing at the end as it did at the start, and almost nobody does it — which is how a plan can be met to the letter and still fall short of what it was for.

What it does to a drawdown

A flat year during inflation is a losing year, and a losing year is worse than it appears. The S&P 500’s longest wait for a new record close ran 1,897 trading days, from January 1973 to July 1980 — counted in nominal dollars, through years of high inflation. In real terms the hole is deeper and the wait is longer, because the level you are trying to get back to has moved up while you were below it.

Recovering to the old number is not recovering. The old number buys less than it did.

The original data

Thirty years of an annual charge, compounded with no return assumed: 5 basis points removes 1.5% of the final balance, 20 removes 5.8%, 75 removes 20.2%, 150 removes 36.5%.

Inflation runs the identical arithmetic at a much larger number. Three percent is 300 basis points — twice the largest fee in that list, charged to everyone, on every unit of currency held, every year.

Nominal records flatter the recovery. The S&P 500 closed below its prior record on 93% of trading days from 1950 to 2026, and each record that ended one of those waits was counted in dollars, not in what the dollars could buy.

One honest caveat: it is a measurement, not an observation. Nobody sees inflation; a statistical agency estimates it from a basket of goods, and the basket is an average across a whole population.

Your own rate is different from the published one and there is no way to know by how much. If your spending is weighted toward things rising faster than the average, the headline figure understates what is happening to you.

When it fails

The characteristic failure is judging a long-run result in nominal terms. An account that doubled over twenty years sounds like a success and may be close to flat once the unit is held constant. The number went up, the comparison was never made, and the strategy that produced it gets credited with a result it did not achieve. The fix is unglamorous: every long-horizon figure has to be stated in real terms or it is not a claim about purchasing power at all.

A second failure is assuming assets automatically keep pace. Some do over long periods and none do reliably over short ones, and “inflation hedge” is a claim that needs evidence rather than a category.

A third is treating cash as the option with no downside. It carries no price risk and a certain real cost, which is a trade-off rather than an absence of risk.

A fourth is comparing today’s price to an old one without adjusting, which makes every historical level look cheap.

The question: Five percent nominal, three percent inflation. Real?

And a fifth is forgetting that the published figure is not yours. It is an average over a basket somebody else assembled, and your own spending is the only rate that decides whether you are better off.

Related

Interest rate covers what money earns, which is the other half of the real return. Risk management covers sizing against a target that moves every year. And expectancy covers measuring an edge once every cost is counted.

This page is educational, not financial advice. Test every idea on your own charts before risking money.