The nominal rate of return on an investment is the rate at which an investment generates a profit or loss, without factoring in additional financial information. If someone makes an investment of $100 US Dollars (USD), for example, and receives a return of $110 USD, then the nominal rate of return on that investment was 10%, which is the percentage of profit made on it. In contrast to this value is the real rate of return, which factors in other financial considerations, such as taxes or inflation, to create a more realistic value for the return.
A nominal rate of return on an investment is typically the most basic and simplest rate that can be considered with regard to an investment. Whenever a particular investment opportunity specifies the return rate on the investment, it is typically providing a nominal rate of return unless indicating otherwise. This rate is quite simple to calculate, as long as the initial investment value is known as well as the final return value. It is also important to consider that this type of rate is usually a “simple” rate that does not include increased value due to compounding.
For someone to determine the nominal return rate on an investment, he or she simply determines the profit and divides it by the initial investment. Someone making an investment of $100 USD, who receives $150 USD back has made $50 USD in profit. This amount is then divided by the initial investment amount to generate the nominal rate of return, which is 50%. Such a rate might also be referred to as the simple or annual rate of return, depending on the time span over which it is calculated.
While the nominal rate of return on an investment is important, investors should always consider the real rate of return. The real rate is the nominal return rate adjusted for other financial considerations, such as taxes, compounding returns, and inflation. If someone invests $100 USD, and makes $110 USD, then the rate of return would seem to be 10%. When this amount is then adjusted for inflation, however, it can be substantially less. A positive inflation percentage is typically subtracted from the nominal rate, so that a rate of 10% in an economy with 3% inflation would have a real rate of return of only 7%.
