Does inflation help or hinder leveraged investments

Does inflation help or hinder leveraged investments ?

I've read a debate on another forum where they are discussing whether inflation helps or hinders investors.

There seem to be two arguments:

The first argument says borrowing money now and paying it back using tomorrow's dollars makes investment great for people using leverage (borrowed money). This works because inflation means that it's easier to get $1000 in the future to pay back our loan than it is to get that same $1000 today (our rate of pay would have increased in the future, making the amount of effort required to earn $1000 much less then than it is today). Or, flip that around and it says, the future value of $1000 is less than it is today (hence it costs us less to pay it back at some point in the future). This argument implies that the higher the rate of inflation, the better it is for people with loans.

The other argument says that your investment returns have to "keep up with inflation" to maintain their value. For example, if you had $1000 in cash today, it would have less purchasing power in 10 years time because of inflation. You money is decreasing in value over time. If you were to invest that money in the bank - and if your money wasn't growing faster than the rate of inflation - then your money will also decrease in value over time (although at a slower rate than if you hadn't invested it at all). This argument implies that the lower the rate of inflation, the better it is for people investing.

So, which argument is correct ?

Well, I did some thinking about it, and some modelling using a spreadsheet, and my analysis has concluded this:

They are BOTH correct !!

(don't you hate that ? )

Both arguments actually have an impact on the future returns of your investments. Borrowed money gets cheaper to pay back over time, but the real value of your investments decrease over time - both due to inflation.

In fact, my spreadsheet (which I won't upload right now, because it would take me too long to explain it all) shows that there is a point of inflection where inflation changes from a help to a hinderance. Where this point actually sits depends on a multitude of variables, but let me explain my basic scenario.

$20K cash put in as a deposit
$80K borrowed
$100K purchase price
30 year interest only loan payments, with full principal paid out at the end of 30 years.

I calculated the Net Present Value (NPV) of the payments over 30 years, and compared this with the NPV of the total returns (growth + income, ignoring tax) over the same 30 years. I then changed the interest rate and inflation rate, and each time I had the spreadsheet solver calculate what the minimum total return each year was to ensure that the NPV of returns was at least equal to the NPV of the payments.

I then plotted those minimum return values in a chart against the interest rates, and it showed that for lower interest rates, higher inflation improved the returns, while at higher interest rates, higher inflation hindered returns.

In my scenario, the point where the inflection occurred was when interest rates were around 8%. I haven't done enough analysis to work out how this figure changes as the assumptions in the scenario change - and it's certainly not a fixed point.