On the calculation of ‘real’ investment returns

Abstract

1. The rise in the general level of prices that has occurred in Britain at varying speeds over the last half century has caused many investments to appreciate considerably in money terms, but without this necessarily representing any increase in the purchasing power of the monetary proceeds. It has for some time been desirable to adjust for changes in the general purchasing power of money, and to calculate returns on investment ‘in real terms’. The issue by the British Government of Index Linked Treasury Stocks provides investments whose future return is defined in terms of the Retail Prices Index (R.P.I.), and it is desirable to calculate ‘real’ redemption yields on these stocks. There has been some discussion about how such real yields should be calculated, and, as will be seen, it is necessary to make certain assumptions in order to produce explicit results. The Joint Investment and Index Committee of the Institute of Actuaries and the Faculty of Actuaries has asked me to prepare this note in order to explain the details of how real yields should be calculated, and what assumptions need to be made and stated. I am very grateful to the members of the Committee, particularly the Chairman, R. H. Pain, for their assistance in its preparation.