Explanation :The rule of thumb in finance is that the value of money today is higher that the value of money in the future because of interest rates and inflation. When calculating investment returns, analysts determine the difference between the nominal rate and the real return, which adjusts to the current purchasing power. If the expected inflation rate is high, investors expect a higher nominal rate. However, in some cases, the nominal rate is misleading. For example, if an investor holds a corporate bond and a municipal bond with a nominal value of $1,000 and an expected nominal rate 5%, one would assume that the bonds are of equal value. However, corporate bonds are taxed at 30%, whereas munis are tax exempt. Therefore, their real rate of return is completely different.
In a nutshell :
- The nominal rate of return is the amount of money generated by an investment before factoring in expenses such as taxes, investment fees, and inflation.
- The nominal rate of return helps investors gauge the performance of their portfolio by stripping out outside factors that can affect performance such as taxes and inflation.
- Tracking the nominal rate of return for a portfolio or its components helps investors to see how they're managing their investments over time.