The real rate of return is an important personal finance concept to understand. It’s the rate of return on your investments after inflation is accounted for. The real rate of return indicates whether you are gaining or losing purchasing power with your money.

What is the Real Rate of Return?

So, let’s look at a hypothetical example. If inflation checks in at a rate of 6%, does that mean any investment with less than a 6% rate of return is losing purchasing power? In theory, yes. But it can get complicated when addressing this concept in everyday life.

In theory, any investment with less than a 6% rate of return may lose purchasing power. But there are other factors you want to consider as well. For example, are there certain industries and products that are affected more by inflation in a given year? If so, avoiding or cutting back on those products can help you reduce the effect inflation has on your wallet.

Also be sure to ask if inflation rates are likely to continue their current trend or are they transitory effects of broader market changes.

In the end, the real rate of return is only one factor to consider when building a portfolio. Your time horizon, risk tolerance, and goals are the primary drivers and it’s rare that you’ll have to upend your entire portfolio strategy due to inflation.

The Search for New Investments Isn’t for Everyone

With the high rates of inflation of today, many look for higher-yielding assets to offset the effects of inflation. For many, that can be a prudent decision that can help keep their retirement plans on course. But there are cases in which changing your portfolio strategy may be more costly than it’s worth.

For example, if you must pay early withdrawal fees in order to access the investments everyone else seems to be used to offset inflation, it may cost you more than your peers to make that switch. In other cases, you might find that the inflation-resistant asset classes you seek to replace your relatively low savings account rates come with low liquidity, meaning that in the case of an emergency, you may not have access to your funds without paying hefty fees.

A financial professional can help you better understand market conditions and build an investment strategy that manages both the potential loss of purchasing power through inflation, as well as the investment risks that come with each new opportunity. Sign up with us today for a complimentary review of your finances.