What Is the Real Rate of Return?

The real rate of return is the annual percentage of profit earned on an investment, adjusted for inflation. Therefore, the real rate of return accurately indicates the actual purchasing power of a given amount of money over time.

Adjusting the nominal return to compensate for inflation allows the investor to determine how ജmuch of a nominal return is real return.

In addition to adjusting for inflation, investors also must consider the impact of other 𝕴factors, such as taxes and investing fees, to calculate real returns on their money or to choose among various investing options.

Understanding Real Rate of Return

The real rate of return is calculated by subtracting the inflation rate from the nominal interest rate.

Examples of Real Rate of Return

Assume a bond pays an interest rate of 5% per year. If the inf꧋lation rate is currently 3% per year, then the real return on your savings is ꦐonly 2%.

In other words, even though the nominal 澳洲幸运5开奖号码历史查询:rate of return on your savings is 5%, the real rate of return is only 2%, which means the 澳洲幸运5开奖号码历史查询:real value of your savings increases by only 2% in a year.

Considered another way, assume you have saved $10,000 to buy a car but decide to invest the money for a year before buying to ensure that you have a small cash cushion left over after getting the car. Earning 5% interest, you have $10,500 after 12 months. However, because prices increased by 3% during the same period due to inflation, the same car now costs $10,300.ꦑ

Coꦬnsequently, the amount of money that remains after you buy the car—which represents your increase in purchasing power—is $200, or 2% of your initial investment. This is your real rate of return, as it represents the amount that you gained after accounting for the effects of inflation.

Real Rate of Return vs. Nominal Rate of Return

Interest rates can be expressed in two ways: as nominal rates, or as real rates. The difference is that nominal rates are not adjusted for inflation, while real rates are. As a result, nominal rates are almost always higher, except during those rare per🧸iods when defl🌟ation, or negative inflation, takes hold.

An example of the potential gap between nominal and real rates of return occurred in the late 1970s and early 1980s. Double-digit nominal interest rates on savings accounts were commonplace—but so was double-digit inflation. Prices increased by 11.25% in 1979 and 13.55% in 1980. Therefore, real⛦ rates of return were significantly lower than their nominal-rate counterparts.

So should an investor rely on 𒁃the nominal rate or the real rate? Real rates give an accurate historical picture of how an investment performed. But the nominal rates are what you’ll see advertised on an investment product.

Other factors affecting real rate of return

The problem with real rate of return is that you don’t know what it is until i👍t has already happened. That is, inflation for any given period is a trailing indicator, which can only be calculated after the relevant period has ended.

In addition, the real rate of return isn’t ♐entirely accurate until it also accounts for other costs, such as taxes and investing fees.