Real return

Chapter 6 said prices rise. This chapter is what that does to your returns, and it is the most useful arithmetic in the whole course.

A number on a statement is a nominal return. What it bought you is a real return. They are different, and only one of them is you getting richer.

You divide, you do not subtract

The instinct is to subtract: 7% return, 6% inflation, so 1% real. Close enough for small numbers and wrong in a way that grows.

The correct form is:

real = (1 + nominal) ÷ (1 + inflation) − 1

At 7% and 6%: 1.07 ÷ 1.06 − 1 = 0.94%, not 1%.

The difference looks trivial and is not, because the subtraction error compounds in the same direction every year. Over twenty years, 0.94% turns ₹1,00,000 into about ₹1,20,500 of today's money; the 1% you thought you were getting would say ₹1,22,000. That gap is small here and becomes large at higher rates and longer horizons, and it is always in the optimistic direction.

The reason it is a division is that both quantities are ratios. Your money multiplied by 1.07. Prices multiplied by 1.06. What you can buy multiplied by 1.07 ÷ 1.06.

Then there is tax, and the order matters

Tax applies to the nominal return, not the real one. This is not an opinion about fairness; it is how the rule works, and it has a consequence people find genuinely surprising.

Take an FD at 7% held by someone in the 30% slab:

1. Tax first. 7% × (1 − 0.30) = 4.9% left after tax.
2. Then inflation. 1.049 ÷ 1.06 − 1 = −1.04%.

A negative real return, on a product sold as safe, held by someone doing everything right.

That is not an argument against deposits. Chapter 4 put the emergency fund in exactly this kind of instrument on purpose, because certainty was the point and a small real loss was the price. It is an argument against mistaking a deposit for a way to grow money, which is a different job.

What this means for each thing you can hold

The same two-step — tax the nominal, then divide by inflation — applied across the shelf:

Holding	Typical nominal	Taxed as	Real return, roughly
Savings account	3%	Slab	Clearly negative
Fixed deposit	7%	Slab	Around zero, negative at higher slabs
PPF	7.1%	Exempt	Slightly positive
Equity, over long periods	Higher, uncertain	Capital gains	Positive on average, with no guarantee

Two things fall out of that table.

The tax treatment can matter more than the headline rate. A tax-free 7.1% beats a taxable 7% by more than the 0.1% suggests — at a 30% slab it is the difference between roughly +1% and roughly −1% real.

A "safe" holding is not a safe outcome. Cash and deposits protect the number and lose the purchasing power. Equity risks the number and has historically protected purchasing power over long periods, without any promise that it will. Both are risks; they are just risks of different things, and choosing the one you can see is not the same as choosing the smaller one.

The one number worth carrying

If you take nothing else from this chapter: the return you need is inflation plus what you actually want to gain.

Want your money to grow 3% a year in real terms, with 6% inflation? You need about 9.2% nominal, before tax — and about 13% if it is taxed at 30%. Written that way, "I want a safe 8%" stops being a modest ask and becomes a statement about what you are prepared to hold.

The point

Divide, do not subtract. Tax the nominal return first, then divide by inflation. And treat any rate quoted at you as a starting number rather than an answer.