How do you calculate real rate of return with example?

It is important to consider the real rate of return on an investment before looking to make an investment. In today’s time inflation rate is 5.7%, which means it is reducing the value of money as time passes by and taxes certainly take a chunk away too.
What's left -- the real rate of return -- often can be unimpressive after considering these adjustments. Accordingly, investors must consider whether the risk associated with the investment is appropriate given the real rate of return.

Conclusion

When you are looking at the interest rate after a particular investment, remember there are two ways of looking at this number, the nominal interest earned and the real interest earned.
However, the major difference between both the interest rates is that the former is adjusted for inflation. This is why, most of the time, one’s nominal rate of interest is always higher than the real rate of interest.
To know the exact purchasing power, you can calculate the real rate of return by subtracting the inflation rate of your country from your nominal interest earned on any single investment.

Use the real rate of return calculator to convert nominal rate into an inflation-adjusted real rate of return. Remember that you can use our tools at Omni in multiple directions; this means that when you fill in any two fields, we will calculate the missing one automatically.

Read further and learn what is the real rate of return formula, how to calculate the real rate of return, and see an example that gives you more insight into the subject. To learn more on this subject, check our return on equity calculator.

What is real rate of return?

The **real rate of return is the annual percentage of return on an investment, adjusted for inflation. In other words, the real rate of return is the return that reflects actual growth in terms of future buying power. Therefore, the real rate of return is the return that you would see if there were no inflation.

For example, suppose you invest 1,000 dollars now and receive 1,100 dollars in one year. The nominal rate of return is 10 percent. If the general level of prices increased by 10 percent, that is, the inflation rate is 10 percent, your investment will not provide any additional purchasing power relative to the amount that your initial 1,000 dollars could have purchased. Therefore, you garnered a zero percent real rate of return on your investment.

What is the real rate of return formula?

The simple formula applied in the present calculator is the following:

rr=1+rnom1+π−1r_r = \frac{1 + r_{nom}}{1+\pi} - 1rr​=1+π1+rnom​​−1

Where:

• rrr_rrr​ - real rate of return;
• rnomr_{nom}rnom​ - nominal rate of return; and
• πππ - annual inflation rate.

Now that you know how to calculate the real rate of return, let's see how our real rate of return calculator works!

How to use the real rate of return calculator?

It is a simple calculator with only three variables, which are the following:

• Nominal rate of return;
• Inflation rate; and
• Real rate of return.

You need to set any two of these variables and you will receive the third one immediately.

Now let's look at a couple of examples where you can use the real rate of return calculator.

1. You purchase a bond that pays an interest rate of 6.5 percent per year. If the inflation rate is currently 2.4 percent per year, the real return on your savings is only 4 percent. It means that the real value of your of the invested amount increases by only 4 percent in a year.

2. Assume you have saved 10,000 dollars to buy a car but decide to keep your money in a savings account for a year to accrue a little more. The account offers a 2 percent savings rate. Earning 2 percent interest, you have 10,200 dollars after a year. However, because prices lowered by 1% during the same period due to deflation, you can probably buy the same car slightly cheaper, for 9,900 dollars.

Therefore, the amount of money that remains after you buy the car, which represents your increase in purchasing power, is $300, or 3% of your initial investment. It is your real rate of return, as it represents the amount you gained after accounting for the effects of lowering prices.

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