Concept
Real Return
A real return is the gain on an investment after inflation is taken out, measuring how much more your money can actually buy rather than how many more units of currency you hold.
The interest rate on your bank statement is a nominal return. It counts money, not what money buys. Benjamin Graham kept steering readers back to the second question. A portfolio exists to fund a future life, and that life will be priced in future money. The quick estimate is nominal return minus inflation. The precise version is (1 + nominal) ÷ (1 + inflation) − 1, and the gap between the two widens as inflation rises. Bonds and deposits promise fixed payments, and that fixedness is exactly what rising prices erode. Stocks can outpace inflation over long periods because companies can raise their prices, but they can also lag it for years at a stretch. That is why Graham held both and trusted neither alone. Taxes and fees are charged on the nominal gain, so they bite deeper into the real one than they appear to.
A real-life example
Maya keeps $20,000 in a savings account paying 5%. A year later her statement shows $21,000, and it looks like progress. Inflation that year ran at 6%, so the rent, groceries and fuel that cost $20,000 now cost $21,200. She holds more dollars but can buy less. Her real return is about −0.9%, and the statement never says so.
How to use it
- 1List the nominal rate on every account and fund. Then calculate (1 + rate) ÷ (1 + latest annual inflation) − 1 for each.
- 2Where the result is near zero or negative, ask when that money will be spent. Cash needed soon can accept the loss as the price of liquidity. Money for years from now needs assets that can outgrow prices.
- 3Rerun the numbers after taxes and fees. That is the figure your statement leaves out.