As a baseline guide to calculating the money generated on a particular investment, you will often see reference to what is known as the Nominal Rate of Return – or NROR.
However, this will often disguise the ‘actual’ rate of return which, more often than not, will, typically, be lower.
So just what does Nominal Rate of Return mean?
In short, it is the yield generated on a particular investment – prior to factoring in expenses such as investment fees, trading costs, taxes and the impact of inflation.
For example, if you invest $1,000 and it delivers a return of $250 then the NROR will be 25%. The ‘actual’ rate can then be calculated by taking into account the expenses mentioned above.
While it may not provide you with an accurate picture gain to your overall portfolio costs, NROR does provide a reliable guide as to the growth – or otherwise – of your investment and can help determine your next step.
A key, often overlooked expense to be aware of is, of course, inflation.
Inflation is a measure at which prices for typical goods and services increases year-on-year. If it rises at, say 5%, then what was worth $100 a year ago, will today be the equivalent of $95.
So, a 5% inflation rate over the period of the investment would, effectively, cancel out a 5% gain in the stock’s value.
Taxes will also play a significant role – and will vary from state to state – in taking that headline figure and eroding it a little further.
How is Nominal Rate of Return calculated?
- Subtract the original amount invested from the current market value of the investment.
- Take the result and divide it by the original investment amount.
- Multiply the result by 100 to display the nominal rate of return as a percentage
- For example: If you invest $1,000 and it grows to $1,100, you have seen a 10% NROR.
Why is Nominal Rate of Return useful for investors?
NROR helps an investor to gauge the performance of their portfolio whilst stripping out external factors that can affect an investment’s performance.
By applying NROR, an investor is able to compare and contrast the performance of different investments across various time periods. It provides a simple go-to guide on how the stock has performed.
By factoring in the negative costs outlined, it then delivers an accurate picture to an investor of just how much the ‘real’ return is.
Despite the obvious differences between it and the ‘actual’ rate of return, NROR is still an important metric to observe and one investors should monitor carefully.
Investors should recognize and accept the risks associated with investing.
Certain investments may require you to keep your holding for periods of many years with limited or no ability to resell unless there is a strongly regulated secondary market.
You may also have limited access to periodic reporting, see your holdings decrease and increase in value, or even lose your entire investment.
Investors should decide for themselves whether to make any investment, basing this on their own independent evaluation after consulting with financial, tax and investment advisors.