12 - return Over that same time period inflation was 2 To...

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Why are investors more concerned with the real returns than the nominal returns on their investments? Usually when someone is talking about how well an investment has performed – they are usually talking about the actual percentage increase of the value of that investment over a certain period of time. For example if an investor bought a mutual fund at the beginning of the year for $100 per unit and sold it at the end of the year for $107 per unit, they might say that they “made a 7% return” on their investment. A 7% investment return is pretty decent – at that rate the original investment will double in 10 years. In terms of your purchasing power – after 10 years, it will be no greater than when you made your original investment. The real return of an investment is defined as the total return minus inflation rate (Jain & Khan, 2002). This can also be thought of as the “net return”. Let’s say your portfolio has gone up at a rate of 6% per year for 20 years. This is the total
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Unformatted text preview: return. Over that same time period, inflation was 2%. To get the real return, we subtract 2% from 6% and get a real return of 4% . Using the real return is the best way to measure your long-term investment performance because shows the actual increase in purchasing power. The nominal return is the rate of return on an investment without adjusting for inflation . It is calculated simply by taking the dollar amount of the return and comparing it to the amount invested . A high nominal return does not guarantee a real profit. Nominal returns measure the increase in the dollar value of an investment, but real returns measure how much purchasing power increases over time. If investors care about how much they can buy with the money that they accumulate, then real returns are more important than nominal returns. Nominal returns are important too. For example, investors pay taxes on nominal returns....
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This note was uploaded on 10/15/2011 for the course FIN 550 taught by Professor Smith during the Spring '11 term at Berklee.

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