Real Interest Rate

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DEFINITION of 'Real Interest Rate'

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. The real interest rate of an investment is calculated as the amount by which the nominal interest rate is higher than the inflation rate.

Real Interest Rate = Nominal Interest Rate - Inflation (Expected or Actual)

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BREAKING DOWN 'Real Interest Rate'

The real interest rate is the growth rate of purchasing power derived from an investment. By adjusting the nominal interest rate to compensate for inflation, you are keeping the purchasing power of a given level of capital constant over time.

For example, if you are earning 4% interest per year on the savings in your bank account, and inflation is currently 3% per year, then the real interest rate you are receiving is 1% (4% - 3% = 1%). The real value of your savings will only increase by 1% per year, when purchasing power is taken into consideration.

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RELATED FAQS
  1. What is the difference between real and nominal interest rates?

    A nominal interest rate is the interest rate that does not take inflation into account. It is the interest rate that is quoted ... Read Full Answer >>
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    Inflation is typically defined as a sustained increase in the price level of goods and services. There is no widespread consensus ... Read Full Answer >>
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    When the next Federal Reserve meeting is expected to bring interest rate cuts or increases, it is wise, as a stock investor, ... Read Full Answer >>
  5. What is inflation and how should it affect my investing?

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