The Definition of Real Returns
Businesses and individuals make investments to generate passive returns from savings accounts or equity investments. These groups measure their investments by the financial returns gained from interest rates, the growth of the stock or dividends issued. A common measure is known as the real rate of return.
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Definition
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The real rate of return of an investment is the percentage return less inflation or other factors. Inflation is commonly defined as too many dollars chasing too few goods. With regard to investments, inflation means that the dollars have less purchasing power now than when the investor purchased the stock.
Example
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An investor puts money into a mutual fund account and earns 10 percent interest over the next 12 months. Inflation is 4 percent during the same time period. Therefore, the investor earned a total of 6 percent during this period, which is the real rate of return.
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Considerations
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Businesses that make copious investments through their operational lifetime will often look for the real rate of return, as this figure can vary widely from the nominal rate of return. This ensures that business owners and managers have a better understanding of each investment opportunity.
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