What does 'real rate of return' mean?
Updated 28 February 2019
A real rate of return is an annual percentage investment return that’s adjusted for inflation, taxes or other factors.
Using the real rate of return enables investors to better gauge a security’s performance. It’s calculated by subtracting the inflation rate, or other factor, from the investment return.
For example, a bond pays an interest rate of 5 percent per year, and the inflation rate is 3 percent per year. The bond’s real rate of return is 2 percent, meaning the investment’s value is only growing by 2 percent per year.
An investment that only returns the rate of inflation provides no increase in purchasing power.
An investment that returns less than the rate of inflation is actually losing money in real terms, in other words, you'll be able to buy less with your money than you could before because the cost of living has gone up.
Investors should consider an investment’s real rate of return when weighing its risk.