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What Is an Expected Real Interest Rate?

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  • Written By: Alex Newth
  • Edited By: Angela B.
  • Last Modified Date: 09 September 2016
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With most investment vehicles, there is an interest rate attached to the investment that lets investors know how much they can expect to gain on the transaction; this expected real interest rate is one way of measuring the interest rate against inflation. To calculate real interest rate, the inflation rate is subtracted from the nominal interest rate, or the rate investors are told when making the investment. Economic specialists commonly forecast inflation rates, and this is known as the expected rate. While the expected rate is normally calculated very carefully, the expected real interest rate may not be the same as the actual real interest rate, so investors should only use it as a prediction tool, rather than assume this will accurately determine an investment’s real interest rate.

Inflation and deflation are key figures in determining whether an investment is growing and in seeing how well the investment is growing compared to present economic conditions. Real interest rate, whether expected or actual, is equivalent to the nominal interest rate after the percentage of inflation or deflation has been deducted. For example, a 5 percent nominal interest rate minus 2 percent inflation results in a 3 percent real interest rate.

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The expected rate comes in when investors, or anyone figuring out the real interest rate, use the expected inflation rate predicted by economics specialists. Expected inflation, which is generally close to the actual amount, is an educated guess based on figures such as the world economy, how banks are looking, and consumers’ perception of price increases or decreases. Expected inflation is not actual inflation, so this should only be used to plan for investments and investors should not assume this is the actual interest rate. Expected real interest rate is used only for future interest rate estimates and not present estimates, because then the actual inflation rate can be used.

Expected real interest rate can be dramatically different from the actual real interest rate, because of unexpected factors such as recessions or depressions. Other economically charged events, such as war or natural disasters, can affect inflation or deflation in ways that economists cannot predict. Commonly, the actual and expected real interest rate values are nearly the same but, because it is possible that the two will be very different, investors should never assume the expectedrate will be exactly the same as the actual real interest rate.

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allenJo
Post 4

@nony - It’s impossible to accurately forecast inflation rates, regardless of what you think the government economists are doing. That’s why there has been a rush in gold investments.

Gold skyrocketed in value since the Internet bubble burst. While I don’t expect this trend to continue, I think many investors see gold as a safe haven when the specter of high inflation is on the horizon.

Gold is a valuable asset that tends to hold its value over time. Gold investments have beaten interest rates from other investments over the long haul. I do stress the long haul, however; it’s not a commodity for making a quick buck in any way whatsoever.

nony
Post 3

@MrMoody - The problem with inflationary figures is that you can never really trust them. I think the real inflation rate is much higher than what is publicized.

How do you explain gas doubling and tripling in price over the course of an eight year period? Is this merely 3% inflation or something far worse?

I think the government does its own smoke and mirrors accounting gimmicks to bury the real inflation numbers and make the economy seem better than it is. That’s my theory of course, but I firmly believe that it’s true.

MrMoody
Post 2

@everetra - You’re right. That’s why the stock market is the time tested way to beat inflation over time, in my opinion.

Notwithstanding burst and bubble cycles, it’s not uncommon to see the markets deliver 6% or 7% over the long haul. Even if you factor in inflation, you still come out ahead in the end. You need to have some intestinal fortitude of course, to stand the wild swings of the market and the temporary setbacks.

But anyone investing in the market should be thinking long term anyway.

everetra
Post 1

Few people think about the expected real interest rate when making their investments. How do I know this? Because so many people still plunk down their money in CDs and savings, with their puny rates of return.

If you think getting 1% or at best 2% is something to write home about, just factor in inflation of at least 3% and you’ll see that you’re losing money. Thus, your savings plan isn’t really saving anything, is it?

Money is supposed to grow, not stagnate. If inflation doesn’t eat away at its real value something else down the pike will. Perhaps it will be devaluation as a result of too much deficit spending or something like that.

In either case, you need to do the hard math when making your investments and account for inflation.

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