What does 'real rate of return' mean?
Updated 26 August 2021
The real rate of return is a calculation designed to give investors a better picture of the real value of their investments. To work out the real rate of return of your investment, you reduce the nominal rate of return (the one you see on your fund factsheet or statement) by the rate of inflation.
For example, a bond pays an interest rate of 5% per year, and the inflation rate is 3% each year. The bond’s real rate of return is 2%, meaning the investment’s value is only growing by 2% each year.
If your investment increases by 1% and the rate of inflation is 2%, you're actually losing money in real terms, even though on the face of it your investment has gone up in value. Because the cost of living has gone up by 2%, it will cost you more to buy the same things. The fact that your investment hasn't kept pace with the inflation means you'll actually be worse off.
For this reason, it's important that you consider the real rate of return when you're taking a look at the performance of your investment.
If you’d like to know more about inflation, the Bank of England have a handy guide on everything you need to know.