Seeing a percentage on a savings account and not knowing whether it is really a good deal is a common question in personal finance, and it can lead you to make bad comparisons.
This guide explains what the rate of return is, which types exist, and how to calculate the return on an investment.
What is the rate of return?
The rate of return is the percentage that measures how much an investment gains or loses relative to the amount invested over a period, normally expressed on an annual basis. Understanding it is a basic part of financial education, because it lets you compare different financial products on the same scale and make better decisions with your money.
Rate of return vs. interest rate
The interest rate is the price of money that a product pays, for example a savings account. The rate of return measures the total result, which, besides interest, can include price changes or dividends. That is why two products with the same interest rate can have a different return.
Types of rate of return: nominal, real, gross, and fixed
Rates are classified by what they include: the nominal rate does not discount inflation, the real rate does, the gross rate is before taxes, and the fixed rate does not change during the term. Knowing each type helps you decide where to invest your money with realistic expectations, and not just by the highest number.
Nominal rate and real return: the effect of inflation
The nominal rate is the one the product advertises, without considering inflation. The real return is what remains after subtracting it, and it measures how much purchasing power you gain. As an approximation, real return = nominal rate minus inflation.
Hypothetical example: if a product offers an 8% nominal rate and annual inflation is 4%, the real return is around 4%. Check current inflation on the Banco de México website or INEGI before running your own calculation.
Gross rate and net rate: income tax
The gross rate is the return before taxes; the net rate is what you receive after them. In Mexico, the interest generated by some investments is subject to income tax, and the amount depends on each product and your tax situation. Check the official information from the SAT to confirm it.
Fixed rate and variable rate
A fixed rate is known from the start and does not change during the contracted term, as happens with several bank promissory notes (pagarés). A variable rate adjusts with market conditions, for example with a reference rate. That difference explains why some returns move over time, a topic we cover later.
How to calculate the return on an investment step by step
To calculate the return on an investment, use this formula: (final value minus initial value) ÷ initial value × 100. We will use a single hypothetical example in the next three sections: you invest $10,000 pesos and end up with $10,500.
- Gain: $10,500 minus $10,000 = $500.
- Division: $500 ÷ $10,000 = 0.05.
- Result: 0.05 × 100 = a 5% rate of return.
Annual return and annual rate: how to annualize
That hypothetical 5% does not say how long it took to earn. If it came in six months, the simple annual rate is 10%, because it is multiplied by two six-month periods. With compounding, that is, if what you earn is reinvested, the annual return rises to 10.25%.
That is why, when comparing, it is best to express all results as an annual return in the same format. This way you avoid comparing a 5% over six months against an 8% over one year.
Compound interest and reinvestment
Compound interest occurs when the interest earned is added to the principal and also generates interest. Reinvestment is what triggers it. The following table uses a hypothetical rate of 5% per year on $10,000 pesos over three years.
| Year | Without reinvestment (simple interest) | With reinvestment (compound interest) |
|---|---|---|
| 1 | $10,500 | $10,500 |
| 2 | $11,000 | $11,025 |
| 3 | $11,500 | $11,576.25 |
By the third year the difference is $76.25. It seems small, but it grows with the term and the amount.
Total return: price, dividends, and costs
Total return adds up everything an asset generates: the price change plus dividends, minus costs and taxes. It is the calculation worth mastering to evaluate the real performance of any asset that pays dividends.
Hypothetical example: you buy an asset for $100, sell it for $108, receive $2 in dividends, and pay $1 in costs. The total return is (108 + 2 - 1 - 100) ÷ 100 = 9%. If the asset is priced in dollars, the exchange rate also adds to or subtracts from the result in pesos.
With the formula, annualization, compound interest, and total return, you can now evaluate with good judgment any rate you are shown.
GAT nominal and GAT real: how to compare financial products
The GAT (Ganancia Anual Total, or total annual gain) nominal and GAT real are used to compare financial products because they express the total annual gain in the same format. Banco de México defines their formula, and financial institutions publish them for deposit products such as a savings account or a promissory note (pagaré).
The nominal GAT does not discount inflation; the real GAT does, using an estimated inflation rate. To make the comparison fair, use the same term and the same amount for each product, and remember that both are usually reported before taxes.
To simulate your numbers, the CONDUSEF savings and investment calculator lets you compare options with your own amounts and terms.
Why the rate of return changes: Banco de México and monetary policy
The rate of return changes because Banco de México adjusts its monetary policy to control inflation, and that adjustment carries over to the interest rates of bank products and the market. The chain works like this:
- Inflation rises or falls.
- Banco de México decides its monetary policy and sets the reference rate.
- The reference rate influences CETES and bank products.
- Your investment earns more or less.
This outline explains the mechanism; it does not predict movements: decisions depend on the economic conditions of each moment.
Reference rate and CETES from the Federal Government
CETES (Certificados de la Tesorería de la Federación) are securities issued by the Federal Government that are bought at a discount, below their face value, and pay that full value at maturity. Their return tends to move close to Banco de México’s reference rate; when it rises or falls, CETES usually follow.
Check the rates for each auction at Banxico and Cetesdirecto, because this data changes every week and must be verified with a date before using it in a calculation.
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Frequently asked questions
With a hypothetical rate of 12% per year, $10,000 pesos generate $1,200 a year in simple interest, that is, 12% of that amount. If the interest is compounded monthly, the result rises to about $1,268, because what you earn also generates interest. That is why you should always ask whether the rate is simple or compound and whether it is expressed before or after taxes.
It depends on the rate. The method is to divide the annual rate by 12 and multiply it by the amount. With a hypothetical rate of 10% per year, 100,000 pesos earn about $833 per month before taxes. A savings account, a promissory note (pagaré), or a CETE will give different results, so run your own case in the CONDUSEF savings and investment calculator.
The IRR, or internal rate of return, is the discount rate that makes the net present value of an investment's cash flows equal to zero. It is used to compare investments with cash flows on different dates. It is calculated with a spreadsheet or a financial calculator, and an IRR higher than the rate you require usually indicates a better option.
There is no single best institution for everyone: it depends on your term, amount, and need for liquidity. Compare the nominal GAT and the real GAT of each financial institution using the same term and amount, check whether the rate is fixed or variable, and confirm the fees and withdrawal conditions. Then compare the result with the expected return you need for your goal.
Face value is the amount a security promises to pay at maturity; for CETES it is $10 pesos per security. Present value is what that future payment is worth today after discounting it at a rate. Promissory notes (pagarés), for their part, usually pay interest at maturity calculated on their face value. Both concepts help you understand how much an investment costs and how much it returns.
The CETES discount rate is the percentage subtracted from their $10 peso face value to get the price at which they are bought. If you buy below $10 and receive $10 at maturity, that difference is your gain. The discount rate and the rate of return are different, although one can be converted into the other.
The expected return is the gain you estimate from an investment based on possible scenarios, not a guaranteed result. It is calculated by weighting each scenario by its probability: if there is a 50% chance of earning 10% and a 50% chance of earning 4%, the expected return is 7%. No expected return ensures what will actually happen. Use these figures as a hypothetical reference, not as a promise.
No, investment funds do not have a fixed rate of return. Their result depends on the price of the assets they invest in, such as debt or equity instruments, and it can go up or down. Some debt funds move closer to interest rates, but none guarantees a gain. Review the prospectus and track record before comparing it with other products.
