How to Calculate Real Rate of Return

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Understanding and Calculating Real Rate of Return

The real rate of return is a crucial metric for investors as it accounts for the impact of inflation on the purchasing power of their investment gains. While nominal rate of return simply shows the gross increase in your investment, the real rate of return adjusts this for the erosion of value caused by rising prices.

Understanding your real rate of return helps you make more informed decisions about where to invest your money. An investment might show a healthy nominal return, but if inflation is higher than that return, your actual purchasing power has decreased.

The formula to calculate the real rate of return is:

Real Rate of Return = [(1 + Nominal Rate of Return) / (1 + Inflation Rate)] – 1

Where:

  • Nominal Rate of Return: This is the stated return on your investment before considering inflation. It's the percentage gain you see on your portfolio statement.
  • Inflation Rate: This is the rate at which the general price level of goods and services is rising, and subsequently, purchasing power is falling. This is often measured by the Consumer Price Index (CPI).

It's important to use rates expressed as decimals in the calculation (e.g., 5% would be 0.05).

Real Rate of Return Calculator

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