The concept of real interest ratesor real yields hit the headlines last month, raising growth concerns for global investors. To everyday consumers, the phrase meant little, but to professional investors, it meant returns investors expect to earn after inflation.
Everyday consumers are conscious of interest rates. They know they are earning very little by putting their money in the bank. They are also aware of rising inflation, which has dominated the headlines for several months.
What they havent done is put together the concept of how little they really earn on their money in the bank when one strips out the inflation rate. That number is the real rate they are earning.
Investors didnt pay much attention to the real yield when inflation was low in the sub-2% area. This is because the benchmark 10-year U.S. Treasury yield was trading in the essentially the same area. But since the start of the global economic recovery, yields have stayed near historical levels, while inflation has soared to multi-year highs. This has pushed real rates into negative territory.
Many consumers know the interest rate on their savings account, or the money they earn on their balance. However, they probably dont know what their real interest rate is. This article will explain real interest rates.
What is the Real Interest Rate？
Simply stated, a real interest rate is an interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor.
In equation form, the real interest rate is simply equal to the nominal interest rate minus the actual or expected inflation rate.
To understand real interest rates, you have to first understand inflation. Inflation is a general, sustained upward movement in the prices of goods and services in an economy.
Inflation matters when making decisions related to interest rates on savings accounts and other financial assets. For example, when you have a savings account, interest is at work increasing the amount deposited, while inflation is at work reducing its value.
