How is the real return calculated?

The calculation of the real return is achieved through the formula that accounts for inflation's impact on nominal returns, which is represented as (1 + r nominal) / (1 + r inflation) - 1. This formula provides a way to understand the actual increase in purchasing power from an investment after considering the detrimental effects of rising prices.

In this formula, 'r nominal' represents the nominal interest rate or return on an investment, while 'r inflation' indicates the rate of inflation over the same period. By adjusting for inflation, investors can get a clearer picture of how much value their investment has genuinely gained or lost. The real return essentially reflects the returns available to the investor in terms of purchasing power.

This calculation is vital for investors, as it helps them assess the effectiveness of their investments while accounting for changing economic conditions. In this context, understanding the relationship between nominal returns, inflation, and real returns is crucial for making informed investment decisions.