Inflation, Purchasing Power and Compound Interest Explained – Brenxa
Inflation, Purchasing Power and Compound Interest Explained
Understand how inflation reduces your purchasing power, how compound interest grows your money, and why time matters when building wealth.
Chris Awoke · 31 October 2026 · 12-minute read
As I continue learning about the capital market and sharing what I learn, I want to explore some concepts that affect our everyday financial decisions, even when we don't pay much attention to them.
Two of such concepts are inflation and compound interest.
You probably hear people complain that things are becoming more expensive. You may also have heard financial experts talk about the importance of investing early because of compound interest.
But what do these concepts actually mean? How do they affect the money you earn, the money you save, and your ability to build wealth?
Let's break them down.
1. Inflation
Have you ever gone to the market with an amount of money you used to spend comfortably, only to discover that you can no longer buy as much as you used to?
Perhaps ₦10,000 could buy you a particular basket of groceries a few years ago, but today, you need ₦18,000 to buy those same items.
What happened?
One of the reasons is inflation.
Inflation is a sustained increase in the general price level of goods and services over time.
In simpler terms, inflation means that things generally become more expensive over time.
When prices increase, the purchasing power of money decreases.
What is purchasing power?
Purchasing power refers to the quantity of goods and services that a particular amount of money can buy.
For example, let's assume you have ₦50,000.
If a bag of rice costs ₦50,000, your money can buy one bag.
Written by
Chris Awoke
Chris Awoke is the co-founder and CEO of Wikrena Limited, a data education and AI company that builds the skills and systems African professionals and organisations need to make better decisions. Brenxa is his personal decision intelligence project, built to help him think through important decisions with the structured rigour of the world’s best thinkers.
You still have ₦50,000, but you can no longer afford the same bag of rice.
Your money has lost some of its purchasing power.
This is an important distinction to understand:
The amount of money you have and what that money can buy are two different things.
You could have ₦1 million in your bank account today and still have ₦1 million in that account next year. However, if prices increase during that period, the money may buy fewer goods and services than it could before.
This is why simply keeping money is not always enough to preserve its value.
Why does inflation happen?
Inflation can happen for several reasons. Some of the common ones include:
1. Demand-pull inflation
This happens when demand for goods and services increases faster than the economy's ability to supply them.
For example, imagine there are 100 bags of rice available in a market, but 200 people want to buy them.
If supply cannot increase to meet the demand, sellers may increase their prices.
2. Cost-push inflation
This happens when the cost of producing or supplying goods and services increases, and businesses pass some or all of those additional costs to consumers.
For example, if the cost of fuel, electricity, transportation, or raw materials increases, a manufacturer may spend more money producing the same product.
To maintain its profit margin, the manufacturer may increase the selling price.
3. Monetary factors
Changes in the money supply and monetary conditions can also contribute to inflation.
For example, when the amount of money circulating in an economy grows significantly faster than the production of goods and services, it can contribute to upward pressure on prices.
These are some of the factors that can drive inflation. In practice, several of them can occur at the same time.
How is inflation measured?
Inflation is commonly measured using the Consumer Price Index (CPI).
The CPI tracks changes in the prices of a basket of goods and services commonly consumed by households.
This basket includes items such as food, housing, transportation, healthcare, and other everyday expenses.
The percentage change in the CPI over a period gives us the inflation rate for that period.
For example, if the inflation rate is 15%, it means the general price level, as measured by the CPI, has increased by 15% compared with the corresponding period a year earlier.
It does not mean that every product has increased in price by exactly 15%.
Some items may have increased by 30%, others by 5%, while some may have become cheaper.
If food and transportation account for a large portion of your income, increases in those categories may affect you more than someone whose spending pattern is different.
What does inflation mean for your finances?
Let's bring this home.
Imagine you earn ₦300,000 every month, and your salary remains the same for the next two years.
During that period, the prices of food, transportation, rent, and other expenses continue to increase.
Although your salary has not reduced in naira terms, the amount of goods and services you can afford with it has declined.
This means your income has lost purchasing power.
For example:
Money saved: ₦100,000
Annual savings interest: 5%
Inflation rate: 15%
After one year, assuming the interest is credited and compounded annually, your savings become ₦105,000.
However, the general price level has increased by 15%.
Your money has increased in amount, but it has lost purchasing power in real terms.
This brings us to an important financial consideration: the return you earn on your money should be evaluated against inflation, not just by how much your account balance has increased.
2. Compound Interest
Now that we understand how inflation can reduce the purchasing power of money, let's look at the other side of the equation: how money can grow over time.
One of the most important concepts in investing and personal finance is compound interest.
What is compound interest?
Compound interest is interest earned on both your original investment and the interest that has accumulated over previous periods.
In simple terms, you earn returns on your money, and those returns can also start earning returns.
Let's use an example.
Suppose you invest ₦100,000 in an investment that earns 10% annually.
At the end of the first year:
Initial investment: ₦100,000
Return at 10%: ₦10,000
Total value: ₦110,000
Now, assume you leave the entire ₦110,000 invested and earn another 10% in the second year.
Your return is no longer ₦10,000. It is ₦11,000.
Why?
Because you are now earning 10% on ₦110,000, not just your original ₦100,000.
At the end of the second year:
Opening investment value: ₦110,000
Return at 10%: ₦11,000
Total value: ₦121,000
Notice what has happened.
In the first year, you earned ₦10,000. In the second year, you earned ₦11,000, even though the annual return remained the same.
The additional ₦1,000 came from earning a return on the previous year's return.
That is compounding.
Why does time matter?
The real power of compound interest becomes more noticeable over longer periods.
Let's continue with our ₦100,000 investment, assuming it earns a consistent 10% annually and all returns remain invested.
Year
Investment Value
Initial investment
₦100,000
Year 1
₦110,000
Year 2
₦121,000
Year 3
₦133,100
Year 4
₦146,410
Year 5
₦161,051
Year 10
₦259,374
Year 15
₦417,725
Year 20
₦672,750
Your initial ₦100,000 grows to approximately ₦672,750 after 20 years.
You didn't add another naira to the original investment. The growth came from allowing your returns to remain invested and generate further returns.
This is why starting early can make a significant difference when investing for long-term goals.
It gives your money more time to compound.
The mathematics behind compound interest
There is a formula used to calculate compound growth:
FV = PV × (1 + r)ⁿ
Where:
FV (Future Value): What your investment will be worth at the end of the investment period.
PV (Present Value): The amount you invest today.
r (Rate of Return): The annual rate of return expressed as a decimal.
n (Number of Periods): The number of years the money remains invested, assuming annual compounding.
You don't need to memorize the formula immediately. What matters is understanding how each variable affects the outcome.
A higher rate of return, a larger initial investment, or more time can increase the future value of an investment, although higher returns generally involve higher risks.
Compound interest versus simple interest
It is also important to understand the difference between compound interest and simple interest.
With simple interest, you earn returns only on your original investment.
With compound interest, you earn returns on your original investment and previously accumulated returns.
Using our ₦100,000 investment at 10% annually over five years:
Year
Simple Interest
Compound Interest
1
₦110,000
₦110,000
2
₦120,000
₦121,000
3
₦130,000
₦133,100
4
₦140,000
₦146,410
5
₦150,000
₦161,051
After five years, the compound interest investment is worth ₦161,051, compared with ₦150,000 under simple interest.
The difference becomes more significant as the investment period increases.
3. The Time Value of Money
There is another concept closely related to inflation and compound interest: the time value of money.
The time value of money is the principle that money available today is generally worth more than the same amount received in the future.
Why?
There are three important reasons.
First, inflation. The money you have today may buy more goods and services than the same amount will buy in the future.
Second, earning potential. Money available today can be invested to generate returns over time.
Third, uncertainty. Money promised in the future may not be received as expected. There is always some level of risk involved.
Let's consider a simple example.
Someone offers you two options:
Receive ₦500,000 today.
Receive ₦500,000 exactly five years from now.
Assuming there are no other special circumstances, receiving the money today is generally more valuable.
You can use it, save it, or invest it immediately.
If you invest it and earn returns, you could potentially have more than ₦500,000 after five years.
Meanwhile, if you wait five years to receive the same amount, inflation may have reduced what that money can buy.
This is the thinking behind the time value of money.
It is also why investors consider the time they have to wait before receiving returns when evaluating investment opportunities.
4. Inflation and Compound Interest
Now, let's connect everything.
Inflation reduces the purchasing power of money over time, while compound growth allows money to increase in value over time.
However, there is something important to understand.
An investment can grow in naira terms and still lose purchasing power.
Let's use an example.
Suppose you invest ₦100,000 and earn 10% annually for one year.
Your investment grows to ₦110,000.
However, assume inflation over that same period is 15%.
Although your investment has increased by 10%, the general price level has increased by 15%.
Your investment has not kept pace with inflation.
This means you have earned a positive nominal return but a negative real return.
What are nominal and real returns?
A nominal return is the percentage increase in the monetary value of an investment, without adjusting for inflation.
A real return measures the return after accounting for inflation. It tells you how much your investment has grown in terms of purchasing power.
This means that although your investment grew by 10% in naira terms, its purchasing power declined by approximately 4.35%.
This is a critical distinction when evaluating investments.
You don't just want to know how much money you have made. You also want to know whether that growth has improved your ability to buy goods and services.
Of course, this calculation is illustrative. Actual investment returns, taxes, transaction costs, and personal inflation experiences can affect the outcome.
5. What Should You Take Away From All This?
Understanding inflation, purchasing power, and compound interest changes how you think about money.
Here are some important lessons:
Money can lose value without the amount reducing. Inflation can reduce what your money can buy even when your bank balance remains unchanged.
Saving and investing serve different purposes. You need accessible money for emergencies and short-term needs, but long-term wealth creation may require investments that have the potential to grow.
Time is an important part of investing. The earlier you start investing, the more time your money has to compound, assuming returns are reinvested.
Returns should be measured against inflation. An investment that earns 10% when inflation is 15% has not preserved your purchasing power.
Compounding rewards patience, but returns are not guaranteed. The examples in this article assume consistent returns. Actual investments can experience losses, fluctuating returns, and periods of poor performance.
Action Points
Here are a few things I want you to think about and practice:
Look at how much you spend on basic necessities today. Compare those prices with what you paid two or three years ago. What has changed?
If you have ₦100,000 in a savings account earning 5% annually and inflation is 15%, calculate how much you will have after one year. Then consider what happens to its purchasing power.
Use the compound interest example to calculate how much ₦100,000 could grow to over 10, 15, and 20 years at different annual rates of return.
Think about a long-term financial goal you have. How much would you need to invest regularly to work towards that goal?
Your money has a relationship with time. What you do with it today can affect what it is worth and what it can achieve tomorrow.
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