What is the impact of inflation on investment returns?

Inflation is a critical factor to consider when evaluating investment returns, as it significantly affects the purchasing power of money over time. When inflation rises, the prices of goods and services also increase, meaning that each dollar buys fewer items than before. This scenario directly impacts the real returns on investments, which are adjusted for inflation.

Choosing the statement that inflation erodes purchasing power and can diminish real returns is correct because it highlights how inflation reduces the actual value of investment gains. For example, if an investment returns 5% in a year but the inflation rate is 3%, the real return—the return after accounting for inflation—would only be 2%. This demonstrates how inflation can diminish the effective growth of investments, as the increased nominal returns do not translate into greater purchasing power for the investor.

While other options do not accurately represent the relationship between inflation and investment returns, it's essential to understand that the real impact of inflation on investments is generally negative, as it directly affects the amount of goods and services that future investment returns can purchase.