what is a real interest rate 
a real interest rate is an interest rate that has been adjusted to remove the effects of inflation once adjusted it reflects the real cost of funds to a borrower and the real yield to a lender or to an investor a real interest rate reflects the rate of time preference for current goods over future goods for an investment a real interest rate is calculated as the difference between the nominal interest rate and the inflation rate real interest rate nominal interest rate rate of inflation expected or actual investopedia ryan oakleyunderstanding real interest rateswhile the nominal interest rate is the interest rate actually paid on a loan or investment the real interest rate is a reflection of the change in purchasing power derived from an investment or given up by the borrower the nominal interest rate is generally the one advertised by the institution backing the loan or investment adjusting the nominal interest rate to compensate for the effects of inflation helps to identify the shift in purchasing power of a given level of capital over time according to the time preference theory of interest the real interest rate reflects the degree to which an individual prefers current goods over future goods borrowers who are eager to enjoy the present use of funds show a stronger time preference for current goods over future goods they are willing to pay a higher interest rate for loaned funds similarly a lender who strongly prefers to put off consumption to the future shows a lower time preference and will be willing to loan funds at a lower rate adjusting for inflation can help reveal the rate of time preference among market participants special considerationsthe expected rate of inflation is reported to congress by the federal reserve fed among others reports include estimates for a minimum three year period most expected or anticipatory interest rates are reported as ranges instead of single point estimates 1as the true rate of inflation may not be known until an investment reaches maturity or its holding period ends the associated real interest rates must be considered anticipatory it s important that investors bear in mind current and expected inflation rates when they research where to put their money since the rate of inflation will eat away at the nominal rate of return avoid lower returning fixed income investments that could mean a negligible real rate of return in cases where inflation is positive the real interest rate will be lower than the advertised nominal interest rate for example if an investment such as a certificate of deposit cd is set to earn 4 in interest per year and the rate of inflation for the same time period is 3 the real interest rate earned on the investment will be 1 4 3 when purchasing power is taken into consideration the real value of the funds deposited in the cd will only increase by 1 per year not 4 if those funds were instead placed in a savings account with an interest rate of 1 and the rate of inflation remained at 3 then the real value or purchasing power of the funds in savings will actually decrease the real interest rate would be 2 after accounting for inflation 1 3 