How to Calculate Real Interest on After-Tax Income

Original post by C. Taylor of Demand Media

Interest applies to investment or savings and checking accounts, which earn a certain amount of interest on an existing balance. Your after-tax income represents the amount of money you have to pay bills and invest or save. The amount a balance makes each year is determined by the annual interest rate. However, this nominal interest rate does not take into account inflation, which degrades the effectiveness of the interest earned. Therefore, you may wish to convert the nominal interest rate into a real interest rate.

Step 1

Call your bank and ask for the annual interest rate on your account.

Step 2

Add 1 to this interest rate, in decimal form. For example, assume the bank offers you 5 percent interest, then you will get 1.05.

Step 3

Add 1 to the current inflation rate, which is available through the U.S. Dept. of Labor. In the example, if inflation is 3.6 percent, you would add 1 to 0.036 to get 1.036.

Step 4

Divide the nominal interest rate calculation by the inflation rate calculation. In the example, 1.05 divided by 1.036 gives you 1.0135.

Step 5

Subtract 1 from this number to get the real interest rate. In the example, your 5 percent nominal interest rate has a real interest rate of 0.0135, or 1.35 percent.

References

• Personal Finance: Understand How to Calculate Real Returns
• U.S. Dept. of Labor: Consumer Price Index Summary

About the Author

C. Taylor has been a professional writer since 2009. He has written for online publications and the "Journal of Asian Martial Arts." Taylor specializes in martial arts, traveling, sciences and computer repair. He received a Master of Science in wildlife biology from Clemson University and a Bachelor of Arts in biological sciences from the College of Charleston.