Real and nominal return
Real and Nominal Return Inflation and real and nominal return
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- Let's say last year
- I put $100 into some type of savings account in a bank.
- So this is a year ago,
- and that now today, exactly 1 year later,
- that $100 has grown to $110.
- So this is now.
- So if you look at things just in the absolute dollar terms,
- things have grown by $10,
- so I made $10 off of an original $100 investment,
- so I got a 10% return.
- But what I want to think about is,
- does this really capture
- how much more I can buy with this $110
- than I could buy with that $100 before?
- Can I really buy 10% more goods and services today
- than I could a year ago?
- and to think about that,
- let's think about, well, a hypothetical inflation rate
- from last year to this year,
- so let's say that the inflation ended up being 2%
- between a year ago and today.
- If that's the case,
- what is $100 a year ago in today's money?
- Well, if inflation was 2%,
- then $100 a year ago would buy you the same stuff
- that $102 would buy you today,
- So it would be $102.
- So what is the dollar return in today's money?
- In the current, in today's money?
- The current purchasing power?
- Well, we're getting $110
- We get $110
- and we invest it in today's money, $102.
- If we look at it from today's terms
- we invested something that gives us
- the same purchasing power as $102 today
- and now it's giving us the purchasing power of $110.
- So we've gotten $8 more of purchasing power
- in today's money.
- So what is the actual real return?
- Let me write it... Real return
- and we can do it in today's money
- and you could do it either way,
- you could discount the $110 back to a year ago money
- and figure out the real return there
- and figuring out the actual dollar return
- and do the calculation
- or you can do it in today's money
- and maybe I'll do it the previous way in the next video.
- But the real return is
- we made $8 over the course of the year
- in today's money
- and what we originally invested in today's money
- was $102.
- And so we get our calculator out
- 8 divided by 102 is 7.8%
- so this is equal to 7.8%
- So even though the nominal return,
- if we just look at what we got in exchange
- for what we invested
- even though the nominal return was 10%
- because there was 2% inflation
- our actual purchasing power only increased by 7.8%
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