Nominal vs real return
Your nominal return is the headline number your investment earns. Your real return subtracts inflation to reveal the growth in actual buying power. The precise formula isn't simple subtraction — it's (1 + nominal) ÷ (1 + inflation) − 1 — though "nominal minus inflation" is a close-enough estimate at low rates. A 7% return with 3% inflation is a real return of about 3.9%, not exactly 4%.
Why it changes the whole picture
Real return is the honest measure of whether you're getting richer. Consider the trap of "safe" cash: a savings account paying 2% while inflation runs 4% has a negative real return of about −1.9% — your money grows on paper but buys less each year. Feeling safe while quietly losing purchasing power is one of the most common financial mistakes.
Planning in real terms
- Retirement: a projected $1 million decades away is worth far less in today's money. Planning with a real return (say 4–5% instead of 7%) gives targets in purchasing power you can actually understand.
- Historical context: long-run stock real returns have averaged roughly 6–7%; bonds much lower; cash near zero or negative. These real figures, not nominal ones, are what compound your standard of living.
- Debt cuts both ways: inflation quietly erodes the real value of fixed-rate debt, which is why a low fixed-rate mortgage feels cheaper over time.
Whenever someone quotes a return, mentally subtract inflation. The difference between nominal and real is the difference between looking richer and being richer.