Real vs Nominal Returns

Definitions

Nominal return is the raw percentage change in the dollar value of an investment. If your $10,000 portfolio becomes $10,700, your nominal return is 7%.

Real return is the nominal return adjusted for inflation. If inflation was 3% that year, your $10,700 only buys what $10,388 would have bought a year ago — so your real return is about 3.9%.

The approximation: Real ≈ Nominal − Inflation. The exact formula: Real = (1 + Nominal) / (1 + Inflation) − 1.

Why the distinction matters

If your retirement plan says "we need our portfolio to grow at 6%," which 6%? If that's nominal and inflation runs 3%, you're only growing 3% in real terms — half the planned rate. Over 30 years, that mistake compounds to an enormous shortfall.

Common places the distinction trips people up:

• Historical return quotes. "The S&P 500 has averaged about 10% per year" refers to nominal returns. Real returns are closer to 6.5–7%. Both numbers are right — they just describe different things.
• Bond yields. The yield on a 10-year Treasury is nominal. If it's 4.5% and expected inflation is 3%, the real yield is only about 1.5%.
• Savings account interest. A 5% savings account in a 3% inflation environment delivers 2% real — positive, but modest.
• Social Security COLAs. These are inflation adjustments designed to keep benefits constant in real terms. The nominal check grows each year but the purchasing power stays the same.

Historical benchmarks (real returns)

• U.S. stocks (S&P 500): ~6.5–7% per year real, 1926–present
• U.S. bonds (10-year Treasuries): ~2% per year real, long-run average
• Cash (T-bills): ~0.5% per year real, long-run average
• Real estate: ~1% per year real, long-run average (excluding rental income)

These numbers are long-run averages across bull and bear markets. A "lost decade" in stocks (like 2000–2009) delivered a negative real return. A single great year can deliver 20% real. The averages hold if you stay invested across many decades.

TIPS and inflation protection

Treasury Inflation-Protected Securities (TIPS) pay a fixed real yield on top of whatever inflation turns out to be. A 10-year TIPS yielding 1.8% will deliver 1.8% above inflation, period. That makes them useful for locking in real returns for known future spending — tuition, retirement in 10 years, etc.

Should you plan in real or nominal?

Most retirement plans work better in real terms. Translating all future dollars into today's purchasing power makes the numbers intuitive: "I'll need $80,000/year in today's dollars" is more meaningful than "$170,000 in 25-year dollars."

Horizons does both: the engine operates in nominal dollars internally (because that's what the market gives you), but reports key retirement metrics in today's-dollar equivalent so you can interpret them.

How Horizons uses this

Your expenses inflate at category-specific rates inside the engine, and your assets grow at strategy-specific nominal rates. The retirement readiness calculation then compares your real-dollar spending needs to your real-dollar portfolio, so the readiness score is an apples-to-apples number.