realreturn

Real return is the return on an investment after removing the effects of inflation, representing the change in purchasing power of the invested capital over a period. It is contrasted with nominal return, the observed percentage change in money terms before adjusting for inflation.

To compute real return, let r_nominal be the nominal return and i be the inflation rate over the same horizon. The exact relationship is 1 + r_nominal = (1 + r_real)(1 + i), so r_real = (1 + r_nominal)/(1 + i) − 1. A common approximation when inflation is small is r_real ≈ r_nominal − i. Real return can be calculated using different price indexes, such as the consumer price index (CPI) or the GDP deflator; different measures yield different real returns. Real returns can be annualized or reported over multi-period horizons, and compounding affects the result.

Example: a nominal return of 8% with 3% inflation yields a real return of (1.08/1.03) − 1 ≈ 4.95%. If taxes or fees apply, the after-tax real return is lower, since taxes reduce the nominal return before inflation adjustment.

Applications and limitations: Real return is used to compare investment performance in purchasing power terms, to inform retirement planning, and to assess long-term risk. Limitations include uncertainty in inflation measurement, the choice of price index, taxes and fees, currency effects, and potential differences between expected and realized inflation. Real return provides a clearer view of true wealth growth than nominal figures, though it depends on the inflation measure chosen. See also Fisher equation and real rate of return.