Real return: why the rate on your savings is not what you earn

What does it mean?

Any conversation about what savings earn involves two different numbers: the nominal return and the real return. They are not the same figure, and in some years they point in opposite directions.

Imagine you open a savings account and it pays 5%. That figure is the nominal rate.

It tells you how much bigger the number in your account will be after a year. It does not tell you what that bigger number will buy.

While your money sits in the account, the prices of the things you buy move: rent, food, fuel, school fees. If the account pays 5% and those prices rise 3%, you finish the year with 5% more money that buys 2% more than it did. That 2% is the real return, and it is the only figure that tells you whether you can buy more than you could a year ago.

The rough calculation is subtraction.

For most purposes that is close enough to be useful.

The precise version divides rather than subtracts. A 20% nominal rate against 25% inflationTermInflation×التضخّمA general rise in prices over time, so one riyal today buys less than it did a year ago.Open the term is not a 5% loss but a 4% one, because the erosion applies to the larger balance. The gap between the two methods is small at low rates and grows as rates rise, which means it matters most exactly where inflation is highest.

Real return can be negative. An account paying interest can still leave you able to buy less than you could a year earlier. Nothing about that is unusual and nothing about the account is broken. It is the normal outcome whenever prices rise faster than the rate.

Why should I care?

Because the number the bank advertises and the number that decides the outcome are two different numbers, and only one of them is printed anywhere.

The higher rate can be the worse account. Take the two this guide opened with. The one paying 20% sits in a year when prices rise 25%, and it leaves the saver able to buy about 4% less than they could twelve months earlier. The one paying 4% sits in a year when prices rise 2%, and it leaves them about 2% better off. Sixteen percentage points separate the two headline rates, six points separate the outcomes, and the two gaps run in opposite directions. Nothing about the first account is broken or mis-sold. It pays exactly what it said it would pay, in units that are worth less by the time it pays them.

The bank publishes half of the subtraction. The rate is on the poster, in the app, in the name of the product. The inflation figure that turns it into an answer is published by somebody else, on a different schedule, and nobody involved in selling the account has any reason to put the two side by side. That is not a conspiracy, it is that each party quotes the number it is responsible for. The saver is the only person in the transaction who needs both, and the only one who has to go and find the second one.

A rate is a claim about currency units, and currency units are only worth what they purchase. That is the whole of it: the account reports how many units you will have, and the question you actually had was what those units will buy.

The rate is the smaller of the two numbers, and the only one with a form attached to it. Moving a deposit from one bank to another might change the rate by a point or two, and it takes an afternoon. Inflation over the same year can move by several times that, and no saver picks it. So almost all of the effort goes into the half of the calculation that moves least, because that is the half with a branch, an app and a signature behind it. The larger half arrives without being chosen and is noticed, if at all, in a shop.

And a rate assumes the money comes back when you ask for it. Real return is a calculation about a balance you can reach. A balance and access to a balance are different things, and the second one is what a saver actually holds. A rate applied to money that cannot be withdrawn is arithmetic about a number on a screen.

What should I know?

The headline inflation figure is not your inflation. National statistics agencies measure a basket meant to represent an average household. Your household is not average. If a large shareTermStock×السهمA share of ownership in a company, bought and sold on a stock exchange, that may pay dividends and rise or fall in value.Open the term of your spending goes to rent, school fees, or imported goods, and those categories move faster than the index, your personal erosion is higher than the published figure. The published number is a starting point rather than a personal measurement.

A domestic inflation figure does not price anything bought abroad. The index measures a basket of local prices. It says nothing about what a plane ticket, a foreign university fee or a purchase in another currency costs, and those move with the exchange rateTermForeign exchange×الصرف الأجنبيThe market where one currency is traded for another, at a rate that changes constantly based on supply and demand.Open the term rather than with the index. A saver can hold a positive real return by the published measure and still watch a shrinking ability to buy anything priced outside the country.

No income tax does not mean nothing is taken. Where salaries arrive untaxed it is easy to read a nominal return as arriving intact, and it does. Inflation still takes its share, and it takes it without appearing on any statement or in any tax code. It is the quieter deduction, and it is the one nobody has to notify you about.

Real return compounds, including when it is negative. Compound interestTermCompound interest×الفائدة المركبةReturns calculated on your original money and on every return before it, so the balance grows on itself year after year.Open the term works on what remains after inflation, not on the printed rate. A real return of negative 4% sustained over five years is not a 20% erosion; each year’s loss comes off a balance the year before already reduced, and the compounded figure is about 18.5%. The balance that looks larger every year buys less every year, and the arithmetic that makes saving powerful over long periods works identically in reverse.

A quoted rate may not be the rate you receive. Products quote annual rates, effective rates, and rates net of fees, and these differ. Two nominal figures stated on different bases are not comparable, and a difference that comes from the basis has nothing to do with inflation.