I. Let's assume, we put 1000$ into bank deposit with 5% interest rate. After first year, we get 50$ interests, so our total capital become 1050$. Let's say, that we put total amount (it means 1050$) to the same deposit next year. Interest rate is still 5%, but base to compute interest value is 1050$ (instead of 1000$ in first year).
Let's try to summarize:
II. Unfortunately, the same mechanism can also work against us. If we repeat calculations done above, but assumming, that we lose instead of earning ("negative interest rate"), then it turned out that we lose more and more each year.
Some form of money loss is inflation. Let's say, we put our money under the carpet (instead of bank deposit in first example). What is going on with our money? It's true that amount doesn't change in time - 100$ bill will be still the same 100$ bill after few years. However - it turned out - that it's real value can be smaller in future. The reason of this is price growth. If prices are going up, we can buy less for the same money, so our money are effectively worth less. It's so called decline in purchasing power of money - or simply speaking - inflation.
|Annual inflation (expected)||%|
|Expected rate of return||%|
|Years to predict||years|