What is the impact of inflation on investment returns?

The chosen answer is correct because inflation diminishes the purchasing power of money over time. When inflation rises, the prices of goods and services increase, which means that each dollar you hold will buy fewer items in the future than it does today. This reduction in purchasing power directly impacts the real returns on investments, which is the return adjusted for inflation.

To maintain the same purchasing power of the returns achieved on investments, the nominal returns (the earnings before adjusting for inflation) must be higher. Therefore, if an investment yields a return of 5% but inflation is at 3%, the real return, which reflects the actual increase in purchasing power, is only 2%. This illustrates the necessity for investments to generate higher returns in nominal terms to offset the eroding effects of inflation and preserve real value.

The other options do not accurately reflect the relationship between inflation and investment returns. For instance, fixed-income investments are usually hurt by inflation rather than benefitted, since the interest payments remain constant while the value of money declines. Additionally, claiming that inflation has no effect on real returns overlooks the fundamental impact inflation has on purchasing power. Finally, the idea that inflation guarantees higher investment returns is misleading; while some asset classes may perform well in inflationary