After-Tax Real Rate of Return

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After‑Tax Real Rate of Return

Definition

The after‑tax real rate of return is the profit (or loss) an investment produces after accounting for taxes, inflation, and other costs. It shows the actual change in purchasing power an investor keeps from an investment, expressed as a percentage.

Why it matters

  • Reflects the true increase (or decrease) in wealth after taxes and inflation.
  • Helps determine whether an investment will maintain or improve your future standard of living.
  • More useful than nominal (gross) return when comparing investments or planning long‑term goals.

How to calculate it

  1. Compute the after‑tax nominal return:
    after‑tax return = nominal return × (1 − tax rate)

  2. Convert that into the real (inflation‑adjusted) return:
    after‑tax real return = (1 + after‑tax return) ÷ (1 + inflation rate) − 1

Include commissions and fees before applying taxes if they reduce taxable gains or the effective return.

Examples

Example 1
– Nominal return: 17%
– Tax rate: 15%
– Inflation: 2.5%

Step 1: after‑tax return = 0.17 × (1 − 0.15) = 0.1445 = 14.45%
Step 2: after‑tax real return = (1 + 0.1445) ÷ (1 + 0.025) − 1 ≈ 11.66%

Example 2
– Nominal return: 12%
– Tax rate: 15%
– Inflation: 8.5%

Step 1: after‑tax return = 0.12 × (1 − 0.15) = 0.102 = 10.2%
Step 2: after‑tax real return = (1 + 0.102) ÷ (1 + 0.085) − 1 ≈ 1.57%

Comparison with nominal rate of return

  • Nominal return: gross return before taxes, fees, and inflation.
  • After‑tax real return: net return after taxes, fees, and inflation; a better measure of purchasing‑power gain.
  • Use the same type of return (nominal vs. after‑tax real) when comparing investments.

Factors that reduce the gap between nominal and after‑tax real returns

  • Tax‑advantaged investments and accounts (e.g., municipal bonds, Roth IRAs).
  • Inflation‑protected securities (e.g., TIPS).
  • Lower transaction costs and tax‑efficient investment strategies.

Interpretation

  • A positive after‑tax real return means your investment’s purchasing power increased.
  • A negative after‑tax real return means purchasing power fell despite nominal gains.
  • Consider taxes, fees, and inflation together when evaluating whether an investment meets your long‑term needs.

Bottom line

The after‑tax real rate of return gives the most accurate picture of how an investment affects your wealth over time. Calculate it to compare investments properly and to assess whether returns are sufficient to preserve or improve your future standard of living.