Do you know what inflation is and how to discount it from the profitability of your investments? Have no idea how much real money you are making? No? Ok, don't worry because you will learn everything in this incredible article, which was prepared for you to understand how it affects your purchasing power.
And you can rest assured because here there will be no technical talk, or professional terms, or jargon specific to large financial institutions. In fact, as usual, we have prepared something so that, when you finish the article, you can have all your doubts clarified in a simple and safe way.
Despite the super important subject, inflation is something that few people understand. Hence the need to talk about it in a didactic way. From there, we will relate inflation to your money. Be it what you earn, as a salary, from your work or the income from the investments you make.
What is inflation?
Firstly, let's start with the basics. Inflation is the loss of purchasing power of money. Let's explain this definition using a very simple example: Let's say that at the beginning of January 2021 you bought a pair of pants, and paid R$100.00 for them. Then, at the beginning of the following year, you buy the same pants for R$105.00.
What happened there? It turned out that there was an inflation of 5% this last year. Of course, this is an example to make the matter easier, because, in fact, inflation comes from an ultra-complex calculation. In fact, this calculation is made based on the prices of various products and services offered in several different regions of our country.
There are products that fall in price, there are products that increase in price, but, on average, they increase according to the calculated inflation index. The most important thing now is for you to understand that the purchasing power of the same R$100.00 has been reduced. In other words, you can no longer buy what you could in the previous year.
Indicators for inflation
There are several indicators for inflation, but the most important one for the world of investments, which you need to know, is the IPCA – Broad Consumer Price Index – which is calculated by IBGE – Brazilian Institute of Geography and Statistics – monthly. Therefore, at the end of the year, this same IBGE publishes the annual IPCA rate.
As we live in Brazil, we always need to take inflation into account because it is relatively high, as you can see in this statement below, so you can have an idea of how it impacts both your financial life and in the profitability of your investments:
- 2014 – 6,41%
- 2015 – 10,67%
- 2016 – 6,29%
- 2017 – 2,95%
- 2018 – 3,75%
- 2019 – 4,31%
- 2020 – 10,74%
- 2021 – 10,06%
In 2015, those who invested in savings had a return of 7.94%. In other words, whoever left or put money into savings in 2015, lost to inflation. In other words, the investor lost the purchasing power of his money. The investment not only did not return above inflation, it didn't even reach it!
NOMINAL Profitability vs REAL Profitability
Who would have thought that someone would lose money by putting it in savings? Pay close attention to the impact of inflation, especially on your investments. After all, your investment must always yield above it. NOMINAL profitability is useless, so you need to calculate the REAL profitability of your investment.
REAL profitability is the profitability of the investment already discounted for inflation, which is where you will find out how much real money you made. How do you do this calculation? There is a ready-made formula to reach a reliable result, which is this one: Real Profitability = {[(1 + net income) / (1 + inflation)] – 1} x 100.
You can see that it is a big formula, full of parentheses, brackets, braces, subtraction, division, a lot of things, reminiscent of high school math classes. But if you don't want to invest time calculating by hand, you can look online, where there are several simulators that do this automatically.
But wouldn't it just be subtracting one from the other?
This question must be going through your head. In other words, just take the profitability of the investment and subtract it from the inflation percentage? Unfortunately not. In fact, if you do a simple subtraction, you will get a result that is even close to that of the formula, but it is still a wrong result, mathematically speaking.
So, you can even subtract as a simple “quick fix”, so that you have an idea of the REAL profitability of the investment, but the correct thing is for you, or to apply the formula, or use a spreadsheet, or online simulator to do the very accurate calculation. Remember that we are talking about your money, so it deserves care.
And one detail that needs to be said, before finishing this article, is that it's not just inflation that you should take into account. You also need to discount the taxes and fees that apply to that specific investment, but this will be a subject for another article because this will be limited to explaining inflation issues.
Simplifying the explanation of the article (Summary)
Well, you take the NOMINAL profitability of your investment, discount the month's inflation (which you get in the IBGE official website), subtracts the fees and taxes referring to the value of the profit to, only then, arrive at what we call the REAL profitability of your investment. Remember that revenue is not profit!
We hope the article helped you. If so, share it with your friends who don't quite understand how inflation works and/or how it affects their finances or investments. Financial education is certainly important for everyone and it starts with you learning to to save money in your daily life.
At the tip We are always willing to help you in the best way possible. We believe in the power of financial education as a driving force for a more prosperous, sustainable and happy life. We seek information from the most reliable sources possible and only recommend official websites on each subject covered. Everything made just for you.
