Inflation

CPI is a weighted average across a basket of goods and services meant to represent a typical household. Your own spending mix differs, so if your money goes to rent, education or healthcare and those rise faster than average, your personal inflation will exceed headline CPI. CPI also adjusts for quality; a phone that costs more but does far more is not counted as pure inflation.

For most advanced economies the long-run average sits between 2% and 3%, which is also the target band many central banks aim for. For retirement or education planning, use 3% as the neutral case and run a pessimistic 4% to 5% scenario as well. Inflation is among the least predictable inputs in long-range planning, so it is safer to overestimate than to underestimate.

Deflation is a broad, sustained fall in prices, meaning negative inflation. It sounds welcome but is dangerous: if people expect lower prices they delay purchases, firms cut prices and jobs, demand falls further, and the cycle feeds itself. Japan struggled with this from the 1990s onward, which is why central banks target modest inflation around 2%.

Precisely, real return is (1 + nominal) ÷ (1 + inflation) − 1, so 6% nominal with 3% inflation gives about 2.91% real. For quick work, subtracting inflation from the nominal rate is close enough, here 3%. What matters for judging whether an investment truly grows your wealth is always the real return, not the headline nominal figure.