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I would like to understand a few things about inflation.

Let's suppose I change my currency from EUR to USD, for example, 10k EUR to USD.

Now I invest it in the US Stock market. Let's do an example in the short term and in the long term.

  • A. 2 years
  • B. 10 years

To understand how much I lost in terms of inflation should I consider just the average of inflation during this period of time or should I consider the cumulative inflation?

Let's suppose in the short term I invested from 2020 until 2022. The long term from 2013 to 2023.

What will be the difference in terms of losing money on the stock?

To recover that inflation which should be the gain of Us stock to get some profit?

I am trying to simulate it: enter image description here

What is better, keeping for each year an average return and inflation rate or adding minimum and max to have the average over all the years?

Formula used:

enter image description here

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    fyi related question : How rate of interest affects inflation rate
    – Chris Degnen
    Commented Jul 14, 2023 at 12:17
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    Someone says: "Inflation doesn’t affect your nominal investment return at all" but impacts my power of buying.
    – DevLeo
    Commented Jul 14, 2023 at 13:02
  • Rate of inflation subtracts from rate of growth, when both ste are expressed as percentages. Cumulative inflation subtracts from cumulative growth, ditto. Use whichever produces the number you are trying to obtain. But remember that inflation is out of your control, and in many cases may not affect your strategy that much except in terms of which markets, denominated in which currencies, you want to invest in.
    – keshlam
    Commented Jul 14, 2023 at 14:03
  • ok, but is my opinion correct? should I consider the inflation for each year of calculation or just when I sell a stock, i should consider the cumulative inflation?
    – DevLeo
    Commented Jul 14, 2023 at 14:28
  • Either, depending on what question you are trying to ask...
    – keshlam
    Commented Jul 17, 2023 at 1:41

1 Answer 1

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First of all, inflation is lower in the US compared to the EU at the moment. Assuming the FX rate deteriorates more in the country that experiences higher inflation, you can expect the EUR to depreciate. Insofar, you will gain - not lose.

Given moderate inflation levels and small differences between the two countries that are likely to persist, there is very little you can say about the FX rate in 2 or 10 years.

The FX rate will fluctuate randomly and may increase or decrease given a release of inflation data. Moreover, that is usually not the end of the story. If now, the market expects rate hikes or not, makes a big difference. There will be other news and potentially misleading numbers when looking at core vs headline, or RPI vs CPI levels and so forth.

Looking at the EURUSD exchange rate, as well as CPI in the US and EU shows the following picture on FRED.

enter image description here

As you can see, there is a lot more volatility in the FX rate than CPI differences suggest, something economists call the excess volatility puzzle. This observation lead to the development of the so called overshooting models, initially developed by Dornbusch (1976). You can read some more details about the economic theory behind this here.

That ignores any potentially offsetting price increase in stocks due to inflation. After all, stocks represent ownership in a real business.

Generally speaking though, the main risk for you is the FX rate fluctuation, not inflation when comparing the US with the EU.

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  • I saw it when I bought and sold Nvidia shares. My European brokers use to charge EUR to USD to buy the stocks and again charge USD to EUR when I sold. In a year the return was around 196% (in USD currency) but converting the real return was 164%. Quite a big difference. If I need to add also inflation I need to reduce it again, maybe around 6-10%.
    – DevLeo
    Commented Jul 14, 2023 at 13:43
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    Your example has nothing to do with inflation. It's a nominal return in EUR terms.
    – AKdemy
    Commented Jul 14, 2023 at 14:04
  • why not? at the end the inflation should impact also the return
    – DevLeo
    Commented Jul 14, 2023 at 14:29
  • I agree with @AKdemy the FX rate will impact me much more
    – DevLeo
    Commented Jul 14, 2023 at 14:30
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    @DevLeo when you say "inflation" - what is it that you mean? In the context of your question this term is not very relevant, and the changing value of the currency will be included in your fx risk.
    – littleadv
    Commented Jul 14, 2023 at 18:28

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