Real vs nominal — what did your money actually earn?
This lesson installs the most useful pair of glasses in finance. Once you see the world in "real" terms, you can never unsee it.
The two numbers
- Nominal — the number printed on the contract or the statement: the account paid 4%, the salary rose 6%, the bond yields 5%.
- Real — the nominal number MINUS inflation: what your money can actually buy after the measuring stick shrank.
Quick version of the math: real return ≈ nominal return − inflation. (Purists compound the two properly; the subtraction is accurate enough for thinking, and thinking is what we're here for.)
The savings illusion
Savings account pays 4% — sounds respectable. Inflation runs 6% — your "growing" balance buys about 2% less every year. The account statement shows a bigger number; the supermarket shows the truth. This is inflation's signature move: it taxes cash and cautious savings silently, with no line item, no invoice, and — because nominal numbers keep rising — often no complaint from the taxed.
Why lenders (and you) must think in real terms
Lesson 1 of this course listed inflation compensation among the three rents inside every interest rate. Now you can see the whole game: lenders quote nominal, but they PLAN in real. So should you — any return, salary offer, or pension projection means nothing until you subtract the era's inflation. A 10% return during 12% inflation lost ground; a 3% return during 1% inflation gained it. The number that matters is never the one in large print.
In the data
The US Treasury publishes both glasses for the same borrower. The nominal curve is its ordinary bonds; the real curve comes from its inflation-protected bonds, TIPS, whose payments rise with consumer prices. Here is the real curve on the latest day:
The real curve stops short: five years is its shortest maturity, so there is no 3-month or 1-year real yield to compare with anything. Where the maturities do line up, nominal minus real is the market's breakeven inflation — the inflation rate at which the two bonds would pay you the same — and you compute it yourself: take the ten-year nominal yield, below, and subtract the ten-year real yield above.
Try it now
- Compute the real return: nominal 7%, inflation 3%. Then: nominal 15%, inflation 19% (an emerging-market special).
- Find one headline boasting a nominal figure ("record savings rates!") and mentally re-run it in real terms with current CPI. For a US headline, the latest reading when this was written is below; for another country, use the figure you found in the last lesson.
- Say it aloud: "nominal is what they print; real is what I eat."