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# Real Rate of Return on Investment Calculations

Everyone is interested in the real rate of return of the investments that have been made. However, most investors forget to adjust the rate to inflation and taxes, and as a result don't get real numbers.

So, what they actually calculate is the nominal interest rate. However, the real interest rate is what matters to evaluate the profitability of a particular investment.

Therefore, the real interest rate shows you the growth of your purchasing power, whereas the nominal interest rate shows you the rate of growth of the money you have.

The following example will help you to make a clearer distinction between nominal and real interest rate.

John has invested \$2,000. This investment gives a 7% return. So, at the end of the year John will have \$2,140 or his money has increased with \$140. On the other hand, the economy is experiencing 2.7% inflation rate. So, John's \$2,140 is worth approximately \$2,086. As you can see, inflation has decreased the value not only of the earnings but also of the principal. As a result, John's real rate of return is 4.3 percent.

The most vulnerable groups to inflation are investors that depend on:

• Dividend income
• Interest from bonds
• Fixed-income securities

Since the gains you receive from a stock are accumulated with time, a useful tactic will be to sell the stock when the inflation rates are low.

Stocks are more advantageous than bonds or other savings instruments in inflation terms since the company can pass the inflation cost to consumers. However, the inflation cycle will not be put to an end and will continue to grow.