You will be able to turn any stated interest rate or return into a real return after inflation.
A fixed deposit matures and the bank's letter says you earned 3% over the year. That feels like progress. Over the same year, your groceries, your phone bill and your parents' medical bills went up too. So how much better off are you, in the only sense that matters, which is what the money can buy?
That question has a precise answer, and it takes about ten seconds to work out once you know the method. All the rates in this lesson are examples, chosen to make the arithmetic easy to follow.
The rate on your statement is the nominal return: the percentage your balance grew in dollars. It is the number banks advertise and the number you see in your app.
The real return is how much more your money can buy after inflation is taken into account. It answers the question you actually care about. If your balance grew 3% and prices rose 3%, your nominal return is 3% and your real return is zero. You have more dollars, and they buy exactly what your old balance bought.
Lesson 4.1, Inflation means the same dollar buys less each year, showed purchasing power falling while a balance sits still. Real return puts the two movements together: your balance going up, and the value of each dollar going down.
For everyday use, real return is roughly the nominal return minus the inflation rate.
Earn 3% while prices rise 2%, and your real return is about 1%. Earn 5% while prices rise 2%, and it is about 3%. Earn 0.5% on a savings account while prices rise 2.5%, and it is about minus 2%.
This is fast and close enough for most decisions, especially when both figures are small. It is the version to use in your head when a banker or an advertisement quotes you a rate.
The subtraction is slightly off because inflation applies to your interest too, not only to your original sum. The exact formula is: (1 plus the nominal return) divided by (1 plus inflation), minus 1.
Take the first example. With a nominal return of 3% and inflation of 2%, you calculate 1.03 divided by 1.02, which is about 1.0098. Subtract 1 and you get 0.0098, a real return of about 0.98%. That is just under the 1% the quick estimate gave you.
Here is why. After a year, S$10,000 at 3% has become S$10,300. Prices are 2% higher, so to see what S$10,300 buys in last year's prices, you divide by 1.02, which gives about S$10,098. You are S$98 better off in purchasing power, not S$100.
For the savings account example, 1.005 divided by 1.025 is about 0.9805, so the real return is about minus 1.95%, close to the quick estimate of minus 2%. At low rates the two methods differ by a few hundredths of a percent. At higher rates the gap widens: with 10% nominal and 8% inflation, the shortcut says 2% but the exact answer is about 1.85%. In a spreadsheet, use the exact formula every time, since it costs nothing extra.
A real return below zero happens whenever the rate you earn is lower than inflation. Your balance still rises every month. Your app still shows interest being credited. And yet each year the money buys a little less than it did.
This is easy to miss because nothing on the screen goes down. Take S$20,000 in an account earning 0.5% while prices rise 2.5% a year. After a year the balance is S$20,100. In what it can buy, though, it is worth about S$19,610 in last year's money. That is a loss of almost S$400 of purchasing power, while the account shows a gain of S$100.
None of this means cash is a bad place to keep money. You need cash for spending and for emergencies, and the course The Singapore personal finance system, end to end covers how much to hold. It means you should know the real return on every place you keep money, so that when cash sits idle for years, you are choosing that with your eyes open. Module 5 looks at what you give up for a higher return.
To work out real returns on your own accounts, you need two numbers for each: the rate you actually earn, and an inflation figure. For inflation, use the latest published annual figure from the Department of Statistics, on its SingStat website, rather than a number you remember from the news. Your money map from lesson 1.4 already has the first number on every line, so all that is left is to look up the second and apply the formula.
Write down the rate on each account in your money map and work out its real return using the latest inflation figure from the Department of Statistics.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).