Real Rate of Return Calculator

Understanding Real Rate of Return

An investment's nominal rate of return indicates how much money was gained relative to the original investment. However, evaluating true investment growth requires adjusting for two key factors: taxes on gains and inflation over the investment horizon.

Real Rate of Return Formula

The real rate of return incorporates both tax liabilities and inflation rates:

$$\text{Real Rate of Return} = \frac{1 + R_{\text{after-tax}}}{1 + \pi} - 1$$

Where:

• $R_{\text{nominal}} = \left( \frac{\text{Ending Value}}{\text{Starting Value}} \right)^{\frac{1}{t}} - 1$
• $R_{\text{after-tax}} = R_{\text{nominal}} \times (1 - T)$ where $T$ is the marginal capital gains tax rate.
• $\pi$ is the annual inflation rate over holding period $t$.

Step-by-Step Calculation

1. Calculate total dollar gain and compound annual growth rate (CAGR).
2. Deduct capital gains taxes from profits to establish net after-tax return.
3. Adjust net return for inflation using the Fisher equation to obtain true real purchasing power growth.