Real Returns

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Return in finance/ banking parlance is defined as profit or loss from an investment. To put it in simple words, Return is the amount earned or lost on every single Rupee of investment over time. Now, what exactly is Real Return and why investors should take it seriously.

Real return is the actual return received in hand by the investor after providing for taxation and inflation. Or in simple terms, Real Returns is the return post tax and post inflation. Most of the time investors ignore the effect of taxation and inflation on their investment returns.

Let us take a look at the example below for better understanding: –

An investor in the 30% income tax slab invests Rs 100/- in a bond earning 7% return per annum. Ideally the investor should be receiving Rs. 107/- at the end of year one. However, in reality this is not true. On the Rs. 7/- interest earned, the investor has to pay a tax of Rs. 2.10/-. Which means, the investor only gets Rs. 4.90 in hand reducing his effective returns from 7% to 4.9%.

However, this does not end here. We have still not accounted for inflation during the period. Let us assume an inflation of 5% per annum during the prevailing period (which can be related to Indian situation), the Rupee has got devalued by 5% in the same period. Which implies, Rs. 100/- one year back is today only worth Rs. 95/-.

Now in the above example, did the investor make or lose money? On his investment of Rs. 100/-, his effective in hand returns in absolute purchasing power terms is (Rs. 95.00 + Rs. 4.90) only Rs. 99.90/- after accounting for taxation and inflation, which is nothing but a straight loss.

The stated return on the above investment proposal was 7% per annum. However, the investor’s Real Return was -0.1%. Hence, if the investor continues to invest in this product, he continues to earn negative returns and lose money year on year.

The above example has made it amply clear as to why one should always look at Real Returns before choosing an investment. Ignore Real Returns and you can be certain of poverty. Knowing that will be the difference between working for money and making money work for you. Remember…..An educated investor is a successful investor.

By Manu Nedunkandathil, CFP

Blogger, Investment Consultant, entrepreneur and a dreamer. I usually write on personal finance.

12 replies on “Real Returns”

Very informative! Has conveyed it in the most simplified language. Thanks for sharing. Looking forward for more such articles.

Indept learning. Have very few people who has the audacity to share the true image of someone’s hard earned money. Kuddos…

That was clearly explained… Thanks for that… Your tips have always helped me beat this inflation and tax and reach up to the real returns… I am sure your insight to investments will help more people in earning the real returns…

Well-written article, Manu. It is an easy read. Not many financial jargons used. The examples make the article interesting and we do not leave focus. Looking forward to gather more information on insurance and investments from your upcoming posts.

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