Nominal returns are the raw percentage gains on your investments. Real returns subtract inflation, showing the actual change in your purchasing power. A portfolio gaining 8% while inflation runs at 3% delivers only ~5% real growth — the number that actually determines your retirement lifestyle.
The distinction between real and nominal returns is fundamental to retirement planning. Nominal returns are the headline numbers — the percentage your portfolio gained or lost in a given year. Real returns adjust for inflation, revealing how much your purchasing power actually changed. For a retiree who needs their portfolio to fund 30 years of living expenses, real returns are what truly matter.
How It Works
The relationship between real and nominal returns:
Real Return ≈ Nominal Return − Inflation Rate
More precisely: Real Return = (1 + Nominal Return) / (1 + Inflation Rate) − 1
| Nominal Return | Inflation | Real Return | |
|---|---|---|---|
| Strong year | 12% | 3% | ~8.7% |
| Average year | 7% | 3% | ~3.9% |
| Weak year | 2% | 3% | ~-1.0% |
| Inflationary year | 7% | 7% | ~0% |
Historical long-term averages (U.S. markets):
| Asset Class | Nominal Return | Real Return |
|---|---|---|
| Large-cap stocks | ~10% | ~7% |
| Investment-grade bonds | ~5% | ~2% |
| Cash / T-bills | ~3% | ~0.5% |
The gap between nominal and real returns compounds dramatically over time. At 3% inflation, a $1,000,000 portfolio earning 8% nominally looks like $10,063,000 after 30 years. But in today's purchasing power, it's only $4,140,000 — less than half the nominal figure.
Why It Matters for Retirement Planning
Mixing up real and nominal returns is one of the most common retirement planning errors:
- Using nominal returns with real spending: If you assume 10% portfolio growth but plan spending in today's dollars, you'll dramatically overestimate how much you can withdraw
- Ignoring inflation on fixed income: A bond yielding 4% in a 3% inflation environment delivers only 1% real return — barely growing purchasing power at all
- Cash drag: Cash allocations often earn less than inflation, meaning they're slowly losing real value
For Monte Carlo simulations, consistency matters most: use nominal returns with explicit inflation modeling, or real returns with constant-dollar spending. Mixing conventions produces misleading results.
A Practical Example
A retiree compares two portfolio strategies over 20 years, each starting with $1,000,000:
| Conservative (70% bonds) | Growth (70% stocks) | |
|---|---|---|
| Nominal return | 5.5% | 8.5% |
| Inflation | 3% | 3% |
| Real return | ~2.4% | ~5.3% |
| Nominal value at Year 20 | $2,918,000 | $5,112,000 |
| Real value at Year 20 | $1,616,000 | $2,831,000 |
The conservative portfolio nearly triples in nominal terms — impressive on paper. But in real purchasing power, it barely grows by 62%. The growth portfolio delivers nearly 3x real growth, but with significantly higher volatility. Understanding both the nominal and real picture helps retirees choose the right balance between growth and stability.
Frequently Asked Questions
- What is the difference between real and nominal returns?
- Nominal returns are the raw percentage gain on an investment before accounting for inflation. Real returns subtract inflation, showing the actual change in purchasing power. If your portfolio gains 8% nominally but inflation is 3%, your real return is approximately 5% — that's the true growth in what your money can buy.
- Should I use real or nominal returns for retirement planning?
- Both approaches work if applied consistently. Nominal returns (e.g., 8% stocks) require modeling inflation separately and adjusting spending. Real returns (e.g., 5% stocks) keep everything in today's purchasing power, which many find more intuitive. Monte Carlo simulators typically use nominal returns with explicit inflation to model both effects independently.
- What is the historical real return of the stock market?
- U.S. large-cap stocks have delivered roughly 7% real (after inflation) annual returns over the past century. Bonds have delivered about 2-3% real. Cash has barely kept pace with inflation, earning 0-1% real. These long-term averages mask significant variation across shorter periods.