Exercise 3: Why Both the Nominal and Real Figures Are Correct at Once — Possible Solution ==================================================================== The nominal figure (approximately £38,697) and the real, inflation- adjusted figure (approximately £26,042) are both correct simultaneously because they are answering two genuinely different questions about the same underlying result, not two competing estimates of the same thing. WHAT EACH FIGURE ACTUALLY MEASURES The nominal figure answers: "how many pounds will be in the account after 20 years?" This is a direct, literal count of currency units, and it is exactly what the compound growth formula in this chapter produces when applied to a 7% annual return over 20 years - £10,000 genuinely does grow to about £38,697 in raw pound terms. The real (inflation-adjusted) figure answers a different question entirely: "how much could that future amount of money actually buy, expressed in today's prices?" Because this chapter's own example assumes 2% annual inflation over the same 20 years, prices in general will have risen substantially too - so a pound in 20 years' time simply won't buy as much as a pound does today. Dividing the nominal figure by the same 20-year inflation factor (1.02^20) converts the future pound count into an equivalent amount of today's purchasing power, producing the lower figure of approximately £26,042. WHY NEITHER FIGURE IS "WRONG" Both numbers are mathematically accurate descriptions of the same real outcome - they simply describe it from two different reference points. The nominal figure is correct about the literal quantity of currency that will exist. The real figure is correct about what that currency will actually be able to purchase, once the effect of rising prices over the same 20 years is accounted for. WHY THE REAL FIGURE IS THE MORE MEANINGFUL ONE The real (inflation-adjusted) figure is more meaningful for judging actual purchasing power specifically because purchasing power - what the money can actually buy - is what genuinely matters to a person planning their own real financial future, not the raw quantity of currency itself. A future balance that sounds large in nominal terms can still represent a real decline in wealth if inflation has risen fast enough over the same period, which is exactly the risk this chapter's own cash comparison demonstrates directly. ANSWER: Both figures are correct at the same time because they answer different questions about the identical underlying outcome - the nominal figure (£38,697) is the literal number of pounds that will exist in the account after 20 years, while the real figure (£26,042) is what that future amount is actually worth once converted into today's purchasing power, accounting for the same 2% annual inflation assumed throughout the example. The real figure is the more meaningful one because purchasing power - what the money can actually buy - is what genuinely matters for real financial planning, not the raw quantity of currency alone. WHY THIS WORKS AS AN ANSWER ------------------------------ This explains precisely what each figure measures, why converting between them via the inflation factor is mathematically valid rather than contradictory, and gives the substantive reason (purchasing power being what actually matters) that the real figure is the more useful one for genuine financial decision-making.