Nominal rate and real rate - what is the difference between them?

Quite often it is possible to see, at first glance, favorable proposals that promise financial independence. This can be both bank deposits and opportunities for investment portfolios. But is everything as profitable as advertising says? We will talk about this within the framework of the article, finding out what the nominal rate and real rate are.

Interest rate

But first, let's talk about the basis of the basics in this case - the interest rate. It reflects nominally the benefits that a certain person can receive when investing in something. It should be noted that there are quite a few opportunities to lose your savings or the interest rate that a person should receive:

• The nebula of the contract;
• Unforeseen situations (crisis of an enterprise or a banking institution, as a result of which it ceases to exist).

Therefore, it is necessary to study in great detail what you are going to invest in. It should be remembered that the interest rate is often a reflection of the risk of the project being studied. So, the safest ones are those that offer a yield level of up to 20%. The group of increased risk includes assets that promise up to 70% per annum. And all that is more than these indicators is a danger zone, which should not be avoided without experience. Now, when there is a theoretical basis, you can talk about what is the nominal rate and the real rate.

The concept of a nominal rate

Determine the nominal interest rate is very simple - it means the value that is given to market assets and estimates them without taking into account inflation. For example, you, the reader, and the bank, which offers a deposit at 20% per annum. For example, you have 100 thousand rubles and want to multiply them. Therefore put in the bank for one year. And after the expiration of the period they took 120 thousand rubles. Your net profit is as much as 20,000.

But is it really so? After all, during this time, food products, clothing, travel could have risen in price - and, say, not by 20, but by 30 or 50 percent. What to do in this case, to get a real picture of the cases? What should you still give preference to when you can choose? What should be chosen as a benchmark for yourself: the nominal rate and the real rate or something one of them?

Real rate

Here for such cases, there is such an indicator as the real rate of return. It is noteworthy that it can be easily calculated. To do this, it is necessary to subtract the expected inflation rate from the nominal rate. Continuing the above example, you can say this: you put in the bank 100 thousand rubles at 20% per annum. Inflation was only 10%. As a result, the net nominal profit will be 10 thousand rubles. And if you adjust their cost, then 9,000 on the purchase opportunity of last year.

This option allows you to receive at least a small but profit. Now we can consider another situation in which inflation was already 50 percent. You do not need to be a genius of mathematics to understand that the state of affairs forces you to look for some other way to save and multiply your means. But it was still in the style of a simple description. In the economy, the so-called Fisher equation is used to calculate all this. Let's talk about him.

The Fisher equation and its interpretation

Talking about the difference that a nominal rate and a real rate have, it is possible only in cases of inflation or deflation. Let's look at why. For the first time, an economist, Irving Fisher, put forward the idea of the relationship between nominal and real rates with inflation. In the form of a formula, everything looks like this:

HC = PC + OTI

NA is the nominal rate of return;

OTI - expected rate of inflation;

RS is a real bet.

The equation is used for a mathematical description of the Fisher effect. It sounds like this: the nominal interest rate always changes by the amount at which the real rate remains unchanged.

It may seem difficult, but now we'll figure it out in more detail. The fact is that when the expected rate of inflation is 1%, then the nominal value also grows by 1%. Therefore, it is impossible to create a qualitative process for making investment decisions without taking into account the differences between the rates. Earlier you just read about the thesis, but now you have mathematical proof that everything told above is not a simple invention, but, alas, a sad reality.

Conclusion

And what can we say in conclusion? Always with a choice it is necessary to qualitatively approach the election of an investment project for yourself. It does not matter what it is: a bank deposit, participation in a mutual investment fund or something else. And for the calculation of future incomes or possible losses, always use economic tools. So, the nominal interest rate may give you quite a good profit now, but when evaluating all the parameters it will turn out that not everything is so radiant. And the economic toolkit will help to calculate which decision will be the most profitable.