Nominal Return 

Understanding nominal return is an important part of financial education, especially for people who invest. Whether you are a seasoned trader or a beginner, nominal return is just one of the terms that you will have to learn. We will, hence, explore what nominal return is, how it’s calculated, and how it is applicable in real life. 

By the end of this article, you’ll understand the actual effect of nominal return on your investment strategy as well as its potential risks and benefits. We’ll engage with several real-world cases and answer frequently asked questions to help you sail through the investment path more smoothly. 

What is Nominal Return? 

In its basic sense, it would be the raw increase made on your investment in monetary terms devoid of any extraneous influence from inflation, fees, or taxes to be applied to the investment. As a percentage value, it’ll give you an easily understood measurement of the investment has performance. 

For example, you place USD100,000; after one year of placing it, your investment will already be USD110,000. Your nominal return will be 

Nominal Return = Current Value – Original Investment/ Original Investment × 100 

So in this case: 

Nominal Return = USD1,10,000 – 1,00,000/ 1,00,000 × 100 = 100 10% 

This 10% is your nominal return. It is the raw change in value before accounting for anything outside it, such as inflation or fees. 

Understanding Nominal Return 

The return nominal is significant because it provides a snapshot of the performance investment. However, it is not complete; for instance, it overlooks real factors such as tax and inflation. 

Nominal return is the gross increase in an investment’s value without considering inflation. It is important because while the nominal return may be positive, inflation may eat away at the real return you receive. Moreover, nominal return is helpful when comparing different investments because one can easily compare stocks against bonds or real estate. 

But although it’s a useful measure, nominal return tells you very little about the impact of the investment on your purchasing power or your real wealth; to paint a more colourful picture you need to look at the actual return, which deflates nominal return by inflation. 

Calculations of Nominal Return 

The formula for nominal return is quite straight, transparent, and widely used. Here’s how you do it: 

Step 1: Determine the value of your investment at the start. 

This is your very first financial investment. Let’s assume that you invested USD200.000 in a mutual fund. 

Step 2: Calculate the present value of your investment. 

After one year, the mutual fund has appreciated to USD220.000 

Step 3: The Formula 

Applying the nominal return formula: 

Nominal Return = Current Value – Original Investment/ Original Investment × 100 

For our example: 

Nominal Return = USD2,20,000 – 2,00,000/2,00,000 × 100 = 10% 

This means you earned a nominal return of 10% on your mutual fund investment over the year. 

Need for Time Period 

It is important to note when the return is calculated. A return of 10% over one year is a far cry from the 10% return over five years. In comparing nominal returns, look always at the time period. 

Risks and Considerations 

Although nominal returns are easily calculated and clear, they can be misleading. Here are some risks and considerations: 

Inflation Risk 

A major threat is inflation. This is hurting the real worth of your investment returns. As inflation drives its way up general prices, so do you. 

For example, if you have a nominal return of 5%, but inflation is 3%, then your real return is only 2%. Inflation has an immense influence on the present value of your investment. 

Real Return = Nominal Return – Inflation Rate 

If your nominal return is 10% and inflation is 4%, then your real return is given by, 

Real Return = 10% – 4% = 6% 

Tax and Fee Considerations 

Investors consider the assessment of the real value of an investment, investment management charges, and taxation. Not all investments have taxes, and management charges can lower a profit. 

For example, you may earn a notional 10% return on investment, but the management fees will slash your effective return to 8%. You are losing more in real income if you also owe capital gains tax. 

Examples of Notional Return

Let’s see some practical examples that demonstrate how nominal return works. 

 Example 1: Investments in Stocks 

Assume that you bought 100 shares in a technology company that was priced at USD50 per share. After 12 months, the price of the shares had risen to USD60. This is how you will calculate the nominal return: 

1. Original Investment: USD50 per share 
2. Current Value: USD60 per share 

By applying the formula for nominal return, 

Nominal Return = 60 – 50/50 × 100 = 20% 

This implies that your stock investment yields a nominal return of 20%. 

Example 2: Portfolio Returns 

A maximised portfolio composed of stocks and bonds is examined here. The information provided is as follows: 

• Stock Investment: If USD100000 is invested, the value becomes USD120000. 

• Bond Investment: Its value is USD52.5K if USD50K has been invested. 

The first step is to calculate the nominal return of each asset class: 

Stocks: 

Nominal Return = USD120,000 – 100,000/100,000 × 100 = 20% 

Bonds: 

Nominal Return = USD52,500 – 50,000/50,000 ×100 = 5% 

Calculate overall portfolio nominal return. The total initial investment is USD150,000 and the total current value is USD172,500: 

Overall Nominal Return = USD172,500 – 150,000/150,000 ×100 = 15% 

In this example, you can see the interaction between different asset classes with regard to its Nominal Return. 

Frequently Asked Questions