How to use the real rate of return calculator
- Enter the nominal return, which is the yearly return before inflation, for example the growth rate on a statement.
- Enter the inflation rate you want to test. The 3% shown is an example, so replace it with your own assumption.
- Optionally enter a starting amount and a number of years to see the future value in nominal dollars and in today's dollars.
- Read the real rate from the Fisher equation, compare it with the subtraction shortcut, and check the year by year table.
Formula
Real rate = (1 + nominal) / (1 + inflation) - 1
Shortcut = nominal - inflation
Nominal value = amount x (1 + nominal)^years
Value in today's dollars = amount x ((1 + nominal) / (1 + inflation))^years
The Fisher equation is exact. The shortcut ignores the cross term between the two rates, so it overstates the real rate when both are positive.
Worked example
A return of 7% with inflation of 3% gives a real rate of 1.07 / 1.03 - 1 = 3.8835%. The shortcut says 4%, so it is off by 0.1165 points.
Start with $10,000 and wait 20 years. The nominal balance is $38,696.84. Prices rise by a factor of 1.8061 over the same period, so that balance buys what $21,425.50 buys today, a gain of $11,425.50 in purchasing power.
Nominal and real returns
A nominal return is the percentage change in the number of dollars. A real return is the percentage change in what those dollars can buy. If your account grows 7% while prices rise 3%, your balance is bigger but each dollar buys less, so your buying power grows by less than 7%.
Why the subtraction shortcut drifts
Subtracting is a good mental estimate when rates are low. The gap grows with both rates because your new dollars are worth less by the inflation factor, not by the inflation amount alone. At 20% nominal and 15% inflation the shortcut says 5%, while the exact answer is 4.3478%. When inflation is zero the two methods agree.
Using it for planning
Planning in today's dollars keeps goals comparable over decades. Project savings with the compound interest calculator and then divide by the price level shown here, or work backward with the inflation calculator. To turn two balances into a yearly rate, use the CAGR calculator.
Assumptions and limits
- The nominal return and the inflation rate are fixed for every year. Real returns and prices vary from year to year.
- Both rates are values you enter. The calculator does not look up inflation or forecast returns, and the defaults are examples.
- Taxes, fees and withdrawals are not modeled, so the real rate shown is before them.
- Money is rounded half up to the cent. Rates are shown to four decimal places.
Frequently asked questions
What is the real rate of return?
It is the yearly growth in buying power after removing inflation. It tells you how much more you can buy, not just how many more dollars you hold.
Why not just subtract inflation from my return?
Subtraction is a quick estimate that overstates the result when both rates are positive. The Fisher equation divides by the inflation factor, which is the exact relationship between the three rates.
Can the real rate of return be negative?
Yes. If inflation is higher than the nominal return, your balance buys less each year even though the dollar amount grows. Try a 2% return with 4% inflation to see it.
Which inflation rate should I use?
Use the assumption you want to test, such as a range of low, middle and high values. The calculator does not supply a rate, so the result is only as good as the one you enter.