Answer
The nominal rate of return is the raw percentage increase in an investment's value and doesn't consider inflation. The real rate of return adjusts for inflation, providing a more accurate measure of the investment's true purchasing power growth.
Work Step by Step
The nominal rate of return and the real rate of return differ in the way they account for inflation:
1. **Nominal Rate of Return**: The nominal rate of return is the actual rate at which an investment grows or a financial asset appreciates over time. It does not adjust for inflation and reflects the raw percentage increase in an investment's value. In other words, it considers all elements affecting returns, including both the actual return on the investment and the impact of inflation.
2. **Real Rate of Return**: The real rate of return adjusts the nominal rate for inflation to provide a more accurate representation of the investment's purchasing power. It is the rate at which the real value of an investment grows after considering the eroding effect of inflation. The real rate of return subtracts the inflation rate from the nominal rate to provide a clearer picture of the investment's actual growth in terms of goods and services that can be purchased.
In a nutshell, the nominal rate of return is the raw rate of investment growth,
