Friday, February 19, 2010
Quick Post on Interest Rate Section
Quick post everyone, this is just from learning more about Real Rates of Interest & nominal rates and I felt like I HAD to post it!
There are many determinants in setting the interest rate: Household Savings, Business expenditures and government & FRB fiscal and monetary policies.
Supposed Inflation was 6%, Nominal Interest Rate was 10%. Your Real Interest Rate using approximation method is 4% but the calculated method is only 3.77%. It doesn't end there, because if you are earning interest you are being taxed on that as well.
Let us suppose you are in the 30% tax bracket and we will use the same figures as above. Using approximation, your real-rate is 4%, then net after tax rate would be 4%(1-t) = 2.8%
HOWEVER, the tax code doesn't recognize that 6% of your return is no more than compensation/pay for inflation NOT REAL INCOME, therefore your after-tax real return is reduced by 6%; 6% x .3 = 1.7% and you would subtract that from your 2.8% after-tax-rate, bringing it down to a lowly 1.1% After-Tax Real Interest Rate.
Therefore, you can have a 10% return on something and in actual terms can really only mean 1.1% given the factors of inflation and taxation, weird huh? If anyone wants equations let me know!
-Lanny B.
There are many determinants in setting the interest rate: Household Savings, Business expenditures and government & FRB fiscal and monetary policies.
Supposed Inflation was 6%, Nominal Interest Rate was 10%. Your Real Interest Rate using approximation method is 4% but the calculated method is only 3.77%. It doesn't end there, because if you are earning interest you are being taxed on that as well.
Let us suppose you are in the 30% tax bracket and we will use the same figures as above. Using approximation, your real-rate is 4%, then net after tax rate would be 4%(1-t) = 2.8%
HOWEVER, the tax code doesn't recognize that 6% of your return is no more than compensation/pay for inflation NOT REAL INCOME, therefore your after-tax real return is reduced by 6%; 6% x .3 = 1.7% and you would subtract that from your 2.8% after-tax-rate, bringing it down to a lowly 1.1% After-Tax Real Interest Rate.
Therefore, you can have a 10% return on something and in actual terms can really only mean 1.1% given the factors of inflation and taxation, weird huh? If anyone wants equations let me know!
-Lanny B.
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How will 3.77% go down to 1.1% after tax. can you explain with the formula again. thanks,
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