Real Rate of Return
The Real Rate of Return is the rate of return on an investment adjusted for inflation, reflecting the true increase in Purchasing Power. It is calculated by subtracting the inflation rate from the nominal Interest Rate.
Formula: Real Rate of Return = Nominal Rate – Inflation Rate
Example 1: If an investment has a nominal return of 5% and the inflation rate is 2%, the real rate of return is:
- Real Rate of Return = 5% – 2% = 3%
Example 2: If a Savings Account offers a nominal Interest Rate of 4% and the inflation rate rises to 3%, the real rate of return is:
- Real Rate of Return = 4% – 3% = 1%
Case: An investor earns a nominal return of 8% on Stocks during a year when inflation is 5%. The real rate of return for that investment would be:
- Real Rate of Return = 8% – 5% = 3%
This indicates that the investor’s Purchasing Power has increased by 3% after accounting for inflation.