# Real Rate of Return

## What it is:

## How it works (Example):

Let's say John Doe opens a savings account that offers a 2.5% interest rate (this is called the nominal rate). This sounds like a nice deal, until you consider the 3% inflation rate and the 28% tax John must pay on the interest. Acccordingly, John's real rate of return is negative (2.5% - 3% loss for inflation – 28% tax on interest income).

## Why it Matters:

It is critical to consider the real rate of return on an investment before investing. Inflation, which is often 2% or 3% per year, reduces the value of money as time passes, and taxes certainly take a chunk away too. What's left -- the real rate of return -- often can be unimpressive after considering these adjustments. Accordingly, investors must consider whether the risk associated with the investment is appropriate given the real rate of return.