# Calculate Real Rate of Return: Definition & Examples Explained

## 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 to reflect its true [purchasing power](https://www.investopedia.com/terms/p/purchasingpower.asp) over time. This measure is important for comparing the performance of different investments because inflation can erode nominal gains. In addition to adjusting for inflation, investors should also account for taxes and fees, as these further reduce the real return and provide a more accurate picture of actual investment growth.

### Key Takeaways

*   The real rate of return accounts for inflation, providing a true measure of purchasing power over time.
*   Nominal rates may appear higher, but do not reflect the real growth due to unadjusted inflation.
*   Real returns can be impacted by taxes and investment fees, offering a clearer financial picture.
*   Historical high inflation periods highlight the importance of distinguishing between nominal and real rates.  
    

## Calculating and Interpreting the Real Rate of Return

Calculate the real rate of return by subtracting the inflation rate from the nominal interest rate.

## Practical Examples of Real Rate of Return

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

Even if your nominal [return](https://www.investopedia.com/terms/a/arr.asp) is 5%, your real return is just 2%, so your savings' [real value](https://www.investopedia.com/terms/r/real-value.asp) grows 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.

Consequently, 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.

## Key Differences Between Real and Nominal Rates 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 periods when deflation, or negative inflation, takes hold.

> **Important**
>
> In the late 1970s and early 1980s, the profits from double-digit interest rates were eaten up by the effects of double-digit inflation.

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. Thus, real rates were much lower than nominal rates.

Should investors focus on nominal or real rates? Real rates show true past performance, but nominal rates are what investment products advertise.

### Factors Impacting the Real Rate of Return

A challenge with real rate of return is you only know it after it has occurred. That is, inflation for any given period is a trailing indicator, which can only be calculated after the relevant period has ended.

Including taxes and fees is necessary to know the real rate of return accurately.  

## What Is Trailing?

Trailing refers to the property of a measurement, indicator, or data series that reflects a past event or observation. It is usually attached to a specified time interval by which the data trail or over which that data is aggregated, summed, or averaged. Trailing data and indicators are used to reveal underlying trends but can delay recognition of trend turning points. Trailing can also refer to a type of stop order used by traders.

## What Is the Difference Between a Real or a Nominal Interest Rate?

A [real interest rate](https://www.investopedia.com/terms/r/realinterestrate.asp) is an interest rate that has been adjusted to remove the effects of inflation to reflect the real [cost of funds](https://www.investopedia.com/terms/c/costoffunds.asp) to the borrower and the real yield to the lender or to an investor. A [nominal interest rate](https://www.investopedia.com/terms/n/nominalinterestrate.asp) refers to the [interest rate](https://www.investopedia.com/terms/i/interestrate.asp) before taking [inflation](https://www.investopedia.com/terms/i/inflation.asp) into account. [Nominal](https://www.investopedia.com/terms/n/nominal.asp) can also refer to the advertised or stated interest rate on a loan, without taking into account any fees or compounding of interest.

## What Is Inflation?

Inflation is the decline of [purchasing power](https://www.investopedia.com/terms/p/purchasingpower.asp) of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a [basket of selected goods](https://www.investopedia.com/terms/b/basket_of_goods.asp) and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.

## The Bottom Line

Understanding the difference between nominal and real rates of return is essential for accurately evaluating investment performance. While nominal rates may look appealing on paper, real rates adjust for inflation to show the true change in purchasing power over time.

This distinction is especially important during periods of high inflation, such as in the late 1970s and early 1980s, when nominal gains often overstated actual returns. Investors should also factor in taxes and fees, which further reduce real returns. Regularly assessing investments based on real rates helps ensure more informed decisions and a realistic view of long-term financial growth.  

> **Article Sources**
>
> 1.  Financial Industry Regulatory Authority. "[Bond Yield and Return](https://www.finra.org/investors/learn-to-invest/types-investments/bonds/bond-yield-and-return)."
>     
> 2.  Federal Reserve Bank of St. Louis. "[Getting Real About Interest Rates - The Economic Lowdown Podcast Series](https://www.stlouisfed.org/education/economic-lowdown-podcast-series/episode-14-getting-real-about-interest-rates)."
>     
> 3.  Federal Reserve Bank of St. Louis. "[Federal Funds Effective Rate](https://fred.stlouisfed.org/series/FEDFUNDS)."
>     
> 4.  Federal Reserve Bank of St. Louis. "[Inflation, Consumer Prices for the United States](https://fred.stlouisfed.org/series/FPCPITOTLZGUSA)."