March 22, 2009
Er, what is a real rate of return?
Where do you see this?
In financial and research reports and product ads.
What does it mean?
It refers to the level of returns you earn from an investment after taking into account the impact of inflation.
When investing, you should look at net returns - after expenses have been deducted - and not gross returns. You should then factor in the effect of inflation.
Thus, if you earned 7 per cent on an investment but inflation was 3 per cent, your real rate of return was 4 per cent.
Why is it important?
One of the risks associated with any investment is the effect of inflation, which is the increase in the general price level of goods and services. Inflation adversely affects the purchasing power of your money.
When you read about investment returns, the figures are usually the 'nominal returns' and have not been adjusted for inflation. Therefore, they do not provide a realistic view of your investment.
It is advisable for you to check the annual inflation rate and take that into account, so you can arrive at the real investment return.
So you want to use the term. Just say...
'This stock might look like a good buy, but its real rate of return isn't that hot.'