Financial Modeling Tutorials
- Financial Modeling Basics
- Excel Modeling
- Financial Functions in Excel
- Sensitivity Analysis in Excel
- Time Value of Money
- Future Value Formula
- Present Value Factor
- Perpetuity Formula
- Present Value vs Future Value
- Annuity vs Pension
- Present Value of an Annuity
- Doubling Time Formula
- Annuity Formula
- Annuity vs Perpetuity
- Annuity vs Lump Sum
- Internal Rate of Return (IRR)
- NPV vs XNPV
- NPV vs IRR
- NPV Formula
- PV vs NPV
- IRR vs ROI
- Break Even Point
- Payback Period & Discounted Payback Period
- Payback period Formula
- Discounted Payback Period Formula
- Profitability Index
- Cash Burn Rate
- Simple Interest
- Simple Interest vs Compound Interest
- Simple Interest Formula
- CAGR Formula (Compounded Annual Growth Rate)
- Effective Interest Rate
- Loan Amortization Schedule
- Mortgage Formula
- Loan Principal Amount
- Interest Rate Formula
- Rate of Return Formula
- Effective Annual Rate
- Effective Annual Rate Formula (EAR)
- Daily Compound Interest
- Monthly Compound Interest Formula
- Discount Rate vs Interest Rate
- Rule of 72
- Geometric Mean Return
- Real Rate of Return Formula
- Continuous compounding Formula
- Weighted average Formula
- Average Formula
- Average Rate of Return Formula
- Mean Formula
- Weighted Mean Formula
- Harmonic Mean Formula
- Median Formula in Statistics
- Range Formula
- Expected Value Formula
- Exponential Growth Formula
- Margin of Error Formula
- Decrease Percentage Formula
- Percent Error Formula
- Holding Period Return Formula
- Cost Benefit Analysis
- Cost Volume Profit Analysis
- Opportunity Cost Formula
- Mortgage APR vs Interest Rate
- Regression Formula
- Correlation Coefficient Formula
- Covariance Formula
- Coefficient of Variation Formula
- Sample Standard Deviation Formula
- Relative Standard Deviation Formula
- Volatility Formula
- Binomial Distribution Formula
- Quartile Formula
- P Value Formula
- Skewness Formula
- Regression vs ANOVA
- Real Rate of Return Formula
- Real Rate of Return Formula Calculator
- Real Rate of Return Formula Template
Real Rate of Return Formula
Real rate of return formula helps an investor find out what actually he gets in return for investing a specific sum of money in an investment.
For example, if Mr Timothy invests $1000 into a bank and bank promises to offer 5% rate of return, Mr Timothy may think that he is getting a good return on his investment. In financial terminology, we will call this 5% as nominal rate.
However, the question remains, is 5% the actual return on Mr Timothy’s investment? The answer is no. We also need to consider inflation and also tax (if the return on investment is not tax deductible).
By considering the inflation rate, we can calculate the real rate of return. Here’s the formula –
Example of Real Rate of Return Formula
Let’s take a simple example to illustrate the real rate of return formula.
Ms. Soul has kept $100,000 in a bank. The bank promises to pay 6% rate of return at the end of the year. The inflation rate is 3% during the year. What would be the real rate of return?
By using the formula of real rate of return, we get –
- Real Rate of Return = (1 + Nominal Rate) / (1 + Inflation Rate) – 1
- Or, Real Rate of Return = (1 + 0.06) / (1 + 0.03) – 1
- Or, Real Rate of Return = 1.06 / 1.03 – 1
- Or, Real Rate of Return = 0.0291 = 2.91%.
Explanation of Real Rate of Return Formula
Let’s look into the formula of the real rate of return.
In this formula, we’re first considering the nominal rate and then we will consider the inflation rate.
As you already know – the rate of return on the investment or the bank offers is the nominal rate of return. However, to find out the inflation rate, we need to use the consumer price index. Alternatively, the businesses can use a different consumer price index to calculate the inflation or they can only take the goods and services into account that are related to their business.
Here’s the formula by using which we can find out the inflation rate –
Rate of Inflation = (CPI x+1 – CPI x) / CPI x
Here, CPI x means initial consumer index.
If you have invested a good amount, it’s always prudent to use the real rate of return to see how much you’re actually earning on the investment.
However, if you just want to make sure how much you’re actually making in a casual sense, you can just use the following formula – (nominal rate – inflation rate).
Though this formula is not recommended, you can just check before going into detail.
Use of Real Rate of Return Formula
As you can see already, the real rate of return is quite useful to the investors.
If the investors want to know how much they are actually making (in some cases it is actually negative), In this formula is a good one.
However, there are two things you need to consider before using this formula.
- The first thing is to deduct the inflation rate (or to divide the inflation rate); you need to make sure that you will purchase the same goods the CPI considers.
- The second thing is the rate of return is not always accurate. Yes, you can calculate the real rate of return by using the formula, but there can be more factors that you may need to consider e.g. taxes, opportunity cost etc.
Real Rate of Return Calculator
You can use the following Real Rate of Return Calculator.
|Real Rate of Return Formula =||
Real Rate of Return in Excel (with excel template)
Let us now do the same example above in Excel. This is very simple. You need to provide the two inputs of Nominal Rate and Inflation Rate.
You can easily calculate the real rate of return in the template provided.
This has been a guide to Real Rate of Return formula, its uses along with practical examples. Here we also provide you with Real Rate of Return Calculator with downloadable excel template. Here are the other suggested articles –