Key Takeaways
- Knowing the real rate of return is important for making educated investment decisions and building a portfolio that meets your financial goals.
- It accounts for inflation and provides a more accurate estimate of investment performance than the nominal rate of return.
- When you maximize your real returns for retirement, you will secure a better position to have your investments give you the income you need to support your lifestyle after retirement.
Investing your hard-earned money is a big deal, and you want to make sure you’re getting a good return on your investment. Unfortunately, some investors are only interested in the returns they’ll get from their investments and don’t usually consider the real rate of return. What these investors may not know is that only looking at the absolute return on investment can be misleading.
To get a good understanding of how profitable an investment will be, you need to consider its real rate of return. This considers factors like inflation that can have a big impact on the value of your investment over time. If you are an investor who wants to make sure your investment not only earns a profit but also keeps up with inflation and increases in value, you will want to focus on the real rate of return moving forward. Don’t fall into the trap of just looking at the absolute return!
Understanding Real Rate of Return: Why It Matters for Investors
The real rate of return, also known as real return, is the actual profit gained from an investment over time after taxes and inflation have been accounted for. The real rate of return ensures that the value of a particular amount of money stays the same over time. It’s important to consider this rate before investing because inflation can still lower your investment’s value even after taxes.
When considering an investment, don’t forget to think about the potential risks. Once you consider all the risks that you may face, then you can decide if the expected real return is worth the potential downside.
Crunching the Numbers: How to Calculate the Real Rate of Return
Formula: (1 + Nominal Rate) ÷ (1 + Inflation Rate) – 1.
The nominal rate is simply the rate of return that is advertised or stated on an investment, like the rate offered on a bank account. On the other hand, the inflation rate is generally measured using the Consumer Price Index (CPI). This tracks the average price changes of a specific group of consumer goods and services over time.
Example: Richard invested in a bond that had a nominal rate of return of 7% per year, but inflation was 2.5%. This means the purchasing power of Richard’s money decreased by that amount. If Richard wanted to find his real rate of return, he could use the following formula:
Real Rate of Return = (1 + 7%) ÷ (1 + 2.5%) – 1
Richard’s real rate of return is 4.39%. This takes inflation into account and gives Richard a more accurate picture of the return on his investment.
Why Is It Important to Know the Real Rate of Return?
Maximizing the returns on your investments is one of the many key pieces to achieving financial security. This is why we encourage investors to not only know what the real rate of return is but why it is important to remember it when investing.
- Knowing the real rate of return helps you understand the actual return your investment is generating.
- It gives you a more accurate measure of investment performance.
- Understanding real return can help you make wiser decisions about which investments to choose and how to allocate your resources.
Secure Your Retirement: Maximize Your Real Rate of Return Today
Maximizing your real rate of return is key to securing a comfortable retirement. By understanding how inflation affects your investments and using the right strategies to reduce its impact, you can increase your chances of achieving your retirement goals. At Roberts Tax and Retirement Planning, we specialize in tax and retirement planning and can help you create a customized investment plan that maximizes your real returns. Contact us today to book an appointment and start planning for your future.
