The Return Number You're Using Is Probably Wrong

Your fund statement says you earned 10% last year. The ad for the deposit says 7%. The number looks good, so you bank it as profit.

Here is the question almost nobody asks: how much of that did you actually keep?

Because there is a quieter number working against you the whole time. Inflation skims off the top before you get to spend a single GBP.

The return you should plan around is your real return, not the headline one. And for most people, the real number is a lot lower than they think.

Why Everyone Quotes the Bigger Number

Statements and ads quote the nominal return. It's the bigger figure, it looks better, and it's technically correct.

Nominal just means "before adjusting for inflation." It's the raw growth of your money in GBP terms.

The catch is that you don't live in GBP. You live in groceries, rent, fuel, and school fees. And those prices rose while your money grew.

What Goes Wrong

People treat the nominal number as their real gain. So they assume their money is growing faster than it actually is, and they plan retirement targets in nominal GBP that won't buy what they expect.

The worst case is when inflation is higher than your return. A 5% gain in a year with 6% inflation is not a 5% win. It's a real loss of about 1%. You went backwards while your statement showed green.

"A gain on the statement can still be a loss in real life. The number that matters is what's left after prices rose."

The Fix: Divide, Don't Subtract

The quick way people estimate real return is to subtract: 7% return minus 4% inflation equals 3%. Close enough for a rough check.

But it's not exactly right, and it always flatters you a little. The precise version divides instead of subtracts.

The real rate of return is:

• Real return = [(1 + your return) ÷ (1 + inflation)] − 1

Run the same example through it. (1.07 ÷ 1.04) − 1 comes to about 2.9%, not 3%. The subtraction shortcut overstated your gain.

The gap is small at low rates, but it grows when returns and inflation are high. So when the numbers are big, divide.

What This Does to a Long Plan

This is where the wrong number does real damage. Take the often-quoted "stocks return about 10%." That's nominal. In real terms it's closer to 6% to 7% after inflation.

Watch what that does over 30 years. £100,000 growing at 6% real becomes about £574,000 in today's buying power. The same £100,000 at the headline 10% nominal rate shows about £1,740,000 on paper.

Both numbers are "true." But only the first one tells you what your money will actually buy. If you planned your retirement around the £1.74 million figure, you planned around money that won't exist in real terms.

Common Mistakes

• Treating the nominal return as your real gain.
• Subtracting inflation when you should divide, which slightly overstates the result.
• Forgetting that tax and inflation stack. Tax comes off first, then inflation eats the rest.
• Projecting a retirement target in nominal GBP and assuming it'll buy today's lifestyle.
• Comparing one investment's nominal return to another's real return without noticing.

Common Questions

Is subtracting inflation good enough?

For a quick gut check, yes. 7% minus 4% is roughly 3% and that's fine for a back-of-envelope number. For anything you're planning around, divide instead, because subtraction always flatters the result a little.

Where does tax fit in?

Tax comes off first. Take your after-tax return, then run that through the real-return formula against inflation. Both drains stack, which is why a "7%" return can leave you barely ahead.

Should I lower the return I use in calculators?

It's safer to plan with a real return, or to show both. A good calculator displays your future value and what it's worth in today's money side by side, so you never confuse the two.

Does this mean nominal returns are useless?

No. Nominal is what actually lands in your account and what you pay tax on. It's just the wrong number for judging if you are getting richer in real terms. Use it for the math, judge yourself by the real figure.

The Bottom Line

The headline return is the number that gets advertised. The real return is the number that pays your bills in retirement.

Find the real one, plan around it, and you'll never be surprised by a balance that's smaller in real life than it looked on paper.

Nominal is the headline.

Real is what you keep.

Divide, don't subtract.