Real Rate of Return Calculator

A Real rate of return Calculator can help you understand the real return on your investment. The nominal rate of return tells you the percentage of your investment. Meanwhile the real rate of return tells you the percentage increase in your purchasing power.

For instance, if you get 8% per year for your investment, and the rate of inflation is 5%, the amount of goods you buy with the money you invested will be 3% more than you started with.

People and entities like investors, savers, retirees, financial planners, and those that want to measure investment performance all appreciate when they can find out how their investments have performed in terms of purchasing power.

How to use this Real Rate of Return Calculator

To use this calculator, here are the steps to follow:

• Type in the nominal rate of return on the investment you made.

• Add the rate of inflation.

• The calculator will show your real rate of return.

Make sure that the rate of inflation and nominal rate of return are in the same period of time, or else you will not get accurate results.

The Real Rate of Return Formula

You can choose to calculate the real rate of return using the following formulas:

r 100 = (1 + r) / (1 + I) – 1

where ‘r’ is the nominal rate of return, and ‘I’ is the rate of inflation.

Alternatively, one can also use

Nominal Return – Inflation Rate

The latter is a simplified version of the former. One can use the formula as a good estimation tool for the real rate of return. Although using the exact formula gives an approximate real rate, it doesn’t account for the overall relationship between an investment and inflation.

An Example of What You Should Do

Suppose that you invested Rs. 1,00,000 and your investment has a rate of return of 8%. This year, inflation is 5%.

The exact calculation of the rate would be:

i

1.08/1.05 – 100 = ?

1.0288 – 1 = 0.0288

Hence, in this case, the real return is about 2.88%.

Therefore, the rate at which the money earned for you is about 2.88%. Although your nominal return on investment was 8%, it got reduced to about 2.88% after deducing inflation. On the other hand, the inflation rate reduced your buying power.

What to Do with the Calculated Rate

The reason for calculating the real rate of return is to tell you how well you have performed a certain investment strategy and buying power.

If the real rate of return results in a positive number it implies that your purchasing power has increased. Likewise a zero percent means that your buying power has remained the same.

When the numbers are negative it means that your investment buying power has gone down. Therefore if your real rate of return comes out to be 4%, it depicts how your purchasing power has changed because of an investment. However, it doesn’t say how you will have to pay any tax that an investment might incur. This amount of real return can go either way; a positive means having more money while a negative number could mean having less.

What Affects the Real Rate of Return?

What affects a real rate also consists of some particular elements, namely:

Nominal investment return: This factor affects the results because the larger the proportion of investment growth, the more it will affect the real rate of return. Inflation rate: Like in the previous point, larger rates of inflation will have bigger impacts on the resultant figure.

Other elements such as investment duration or life, taxes and fees for the said investments, and lastly market risk and fluctuation, also have an impact on the real rate of return for investments.

Benefits and Its Applications

There are different benefits for everyone for being able to calculate real rate of return.

Investment Comparison – This tool helps to compare anything from a fixed deposit to different shares and bonds.

Retirement Planning – Using it, you will understand whether your investments will keep you at the same level of comfort, with increasing costs of living.

Financial Expectations – It also helps you to know if your investments will allow one to achieve personal financial expectations and meet some financial goals.

Inflation Insights – With a nominal rate, one could be misled into thinking that their investments are growing rapidly.

Inflation considerations – It allows one to consider inflation when analyzing investments, which in turn gives them a clearer view of investments without the noise of inflation. This feature also makes one put in mind other aspects such as risk, liquidity, and duration to help them make the best financial decisions.

Its Accuracy, Assumptions and Limitations

A real rate of return calculator gives an estimate of the rate of return. Its estimate depends upon the assumptions one will make; therefore, it can be inaccurate sometimes.

It assumes you have given it sufficient information for it to work correctly. It also works from the assumption that the rate of inflation and nominal rate are in the same period, is more precise than simply subtracting the rate of inflation from the nominal rate. This calculator shouldn’t be used as a financial guidance tool.

It only tells you about a yearly return since it works on data of a single calendar year. The number it gives is an approximation of the real rate of return and should be treated as such. Also, to get a precise number, one will have to do a calculation using the exact formula. Finally, the value one has to input in this instrument has to depict the actual value one was using throughout the year of their investment.

Frequently Asked Questions (FAQs)

1. What is the definition of a real rate of return?

A real rate of return is the percentage yield or diminishment of any given investment after inflation has been taken off. Therefore, it helps in measuring the performance of an investment.

2. How is the rate actually calculated?

You can use the below formula to calculate it:

(1+NominalReturn)/(1+InflationRate)-1

Then one will have to enter the decimal value for the nominal rate or inflation that one is using for a yearly figure.

3. What differentiates a nominal and a real return?

Nominal return can be used to depict how your investment grows. At the same time, the real return shows the rate at which one’s buying power increases.

4. Are there instances when the rate can be negative?

Yes, this rate can also be negative. If one’s inflation rate is higher than one’s investment returns, then, it implies that one’s buying power is losing ground, so that, the real rate of return will be negative.

5. Does a high rate of real investment always translate to an increased level of satisfaction?

One can always be dissatisfied with a large rate when various taxes and costs that investments incur weigh it down. One should also be able to measure other components, like risk, liquidity and any fees associated with an investment before one can say they are happy with a high real rate of return for any investment.

6. Does the calculator take care of one’s tax?

While the calculation formula one uses in this calculator adjusts the nominal return by inflation, it does not take any taxes into account.

7. Why do I need to actually calculate an adjusted rate of return?

It allows you to make comparisons between different investments or even saving instruments, and be able to decide on which ones are more viable options for you depending on your financial needs with an accurate reflection of the effect of inflation on an investment.