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What Is a Real Rate of Return?

Adhil Shetty
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Q: What is a real rate of investment return and what role does it play in the long-term? – Shreyashi

A: When investing, people usually consider the nominal rate of return offered by their chosen product. However, in the long-term, the nominal rate of return on your investments might not be enough to meet your financial goals.

Remember, inflation continuously works against your corpus. So, if the rate of inflation is 6% p.a., it means your money is losing value at the rate of 6% every year. If you invest in a fixed deposit at 7% p.a. and you fall in the highest tax bracket, your net nominal return would only be 4.9% p.a. (after reducing tax at 30% rate). If you adjust inflation from 4.9% return, your real return would be in negative, i.e., -1.1% p.a. This means you are actually losing against inflation in the long-term and would, hence, fail to create wealth.

The real rate of investment return is the nominal rate of return after adjusting inflation. While investing for the long-term, ensure that the real rate of return after adjusting taxes is positive. Higher the real rate of return after adjusting taxes, higher would be the wealth creation.

While selecting an investment instrument, it is crucial to look for a product which is tax efficient and offers an attractive return.

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