Do you know the real return on your investment? What is the real rate of return? What you think you will get and what you will actually get are two different numbers. For example, you thought $1,276.94 was your monthly salary, but the in-hand amount you received was only $1,127.62; imagine how disappointed you may feel.
Real Return is the actual amount of profit you receive on your investment after tax deductions. It is actually the annual percentage of your investment. A real return accounts for the inflation rate and describes the gain and loss on your investment more accurately.
Excluding the inflation rate, the ROI or asset is the percent gain value on your original cost.
How to Calculate
It can be calculated simply by subtracting the inflation rate from the nominal amount.
Real Return = Nominal Return – Inflation
The math is simple: if the returns in the year are 4% and the inflation rate is 2%, then the real rate of return will be 2%. This calculation is for any other investment type.
Looking at Real Return
Inflation can reduce your money value, just like taxes. Calculating the rate of return in actual value rather than nominal value shows a clear picture of investment’s success. The nominal rates are lower than the return rates in times of zero inflation.
Assume that it takes $300 a week to feed your family this year, and current inflation is 2%. Then the next year the same food cart will cost you $304, but your investment payback is 1%, then you will have $302 at the end of the year. Your purchasing power will be diminish by the difference between 1% nominal rate and 2% inflation rate. Your real return will be negative by 1%. To manage your investment, pay attention to payback rates.
Real Return Rate vs. Nominal Rate
There are two types of interest rates – nominal interest and the real interest rate. The nominal interest rates are not adjustable for inflation and the real interest rates are adjusted. The nominal rates are always higher except in times of deflation or during negative inflation.
So should an investor count on the nominal or the real rate? The real rates are more accurate than nominal rates. They show a historical picture of how an investment performed, and the nominal rate shows advertising on your product.
Other Factors
The major problem is inflation that is calculated after the relevant period has ended. The other additional accounts such as taxes and investing fees are also cost the accuracy of real return.
