In most parts of the Income Lab application, you can choose to view information in 'real' or 'nominal' terms. This information is not the result of different core calculations and analysis, but rather only the difference in how the effects of inflation are included in the visualization. Both 'real' and 'nominal' views account for inflation, but in different ways.

Using the real/nominal toggle is like choosing which 'filter' you're using to view the data, not a change in the data itself. This article offers a few ways to understand and talk about these 'filters', and some thoughts on when to use each.

The Math

The following equations will help you understand the relationship between 'real' and 'nominal'.

Real = Nominal - Inflation
Nominal = Real + Inflation

For example, a real return excludes the effect of inflation. If the nominal return is 5% and inflation is 3%, the real return is roughly 2%. 'Roughly', because stated using rates, the relationship between real, nominal, and inflation is:

(1 + real) = (1 + nominal) / (1 + inflation)
(1 + nominal) = (1 + real) * (1 + inflation)

Another example of real vs nominal is GDP growth. Imagine the economy grew in a year by 2%. This means that 2% more economic activity happened that year than the prior year. But there was also 3% inflation. If you added up all of the economic activity in the country, you'd see 5% growth, but we wouldn't want to say the economy really grew by 5%. 3% of that growth is just inflation - just people paying 3% more for the same 'stuff'. Only 2% more 'stuff' was produced/consumed. Real growth was 2%. Nominal growth was 5%.

Real as Constant 'Forever' Dollars

Information viewed in 'real' dollar terms strips out the effects of inflation. Basically, this information shows us what the information would be if there were no inflation between now and the future. What costs $4 today costs $4 at all times when considered in 'real' dollars. That's why 'real' is also called 'today's dollars'.

You can think of 'real' dollars as if they were 'forever' dollars (in analogy to 'forever stamps', which will always be enough to send a letter, no matter the current nominal price of a stamp).

For example, imagine that the price of a gallon of milk today is $4 and a gallon of milk 10 years from now is $5.38. By definition, the price ten years from now in real dollars is $4. So that extra $1.38 is the effect of inflation. It just happens that $4 * (1 + 3%) ^ 10 = $5.38, so in this example, inflation has averaged 3% over 10 years.

Real-dollar views show purchasing power through time. For example, if you are using the 'Age-Based' income and spending path (aka the 'retirement smile'), you will see the planned income shaped like a shallow undulating hill. Income late in the plan is lower than income early in the plan to reflect lower needs for consumption at later ages. In this example, the two Social Security benefits are flat through time, showing the inflation-adjusted nature of Social Security. On the other hand, the yellow not-adjusted-for-inflation $2000/month pension slopes down with time in real dollars because that $2000/month stays the same in nominal terms, and so buys less and less as time goes on.

Nominal as 'Dollars in your Wallet' or 'Future Dollars'

Information viewed in 'nominal' terms, on the other hand, is intended to display values more akin to those you'd see on an account statement, a pay stub, or as actual dollars in your wallet. 'Nominal' in this case means 'expressed using the dollar denomination' (or in the currency of choice). Only nominal dollars actually exist for use in the world. If I go to the store to buy milk, they will only take the dollars in my pocket. They won't charge me less if I earned that dollar 10 years ago or if the dollar was printed two years ago. The prices are nominal and the dollars they will take in exchange for goods are nominal.

The means today I might be able to buy a gallon of milk if I have $4 in my pocket, but in 10 years, I may need $5.38 in my pocket. Same milk, same amount of stuff, same 'value' in the world (like the ability to feed people), but a different nominal price.

The nominal setting is also called 'future dollars' because these are the values you'd actually see in the future if the modeled inflation rate holds. In this example, milk costs $5.38 in future dollars in 10 years because that's the price you'd see if you take a gallon of milk to the supermarket checkout in ten years if inflation averages 3% annually between now and then.

Here is the same example as above, but in the nominal view. We can see here how adding expected inflation to the graph makes the undulating shape go up, not down over time. The Social Security income flows also increase in this graph over time, due to inflation. The yellow nominal pension, on the other hand, stays the same throughout the plan when viewed this way.

Which should I use?

The real and nominal views of information are useful for different situations. There are many reasons you might choose one or the other, but here are a few rules of thumb.

There is no difference between 'nominal' and 'real' if we are looking at values for today.

If you are working on a plan for someone who is retired today, their current spending capacity and guardrails are the same whether you are viewing those in real or nominal terms. Their current portfolio balance is also the same whether viewed in 'nominal' or 'real' terms. Since there is no inflation between today and today, real = nominal.

'Nominal' is less confusing for clients when viewing values that don't adjust for inflation and may be a good place to start

Many things in a plan may be constant in nominal terms. For example, a fixed-rate mortgage may have a $2000/month payment. That payment is stated in nominal terms: the client owes the bank that much every month, regardless of inflation.

If you viewed the plan in Life Hub, in the nominal setting, next year's total mortgage payments would be $24,000, but if you switched to real, it might be $23,280 (with 3% inflation). The mortgage payment will appear to be going down! While that is true and correct (inflation actually reduces the cost of fixed expenses over time), it will be confusing to a client. Other examples of fixed income and expenses are insurance premiums and many pensions.

When viewed using the 'nominal' setting, things that are adjusted for inflation over time (like Social Security benefits) will appear to be going up. (In 'real' terms they will appear constant.) It is easier to explain and understand this increase in 'inflation-adjusted' items than to understand the decrease over time of 'not adjusted for inflation' items.

In general, 'nominal' views are likely to be less confusing to clients and may be a great place to start.

'Real' is a good way to view future spending capacity

If you are looking at future ability to spend, it is often a good idea to strip out inflation and view things in 'real' terms. The reason is that humans cannot easily imagine money buying less in the future than it buys now. If I tell you that average wages in 100 years will not be $60,000/year but rather $1.15 million, you would naturally imagine a world filled with incredible wealth. However, I might simply mean that inflation will remain at 3% for 100 years, and that average wages will still purchase the same amount of goods (implying that there will be zero real wage growth over the next 100 years).

Retirement plans won't typically look at spending capacity 100 years in the future, but they might look at it 5, 10, or more years in the future. So, if someone is trying to understand what their plan might mean for the standard of living, 'real' dollars may be best.

'Real' is a good way to view portfolio balances far in the future

Just as with spending capacity, it can be challenging to comprehend the long-term effects of inflation on future asset values. So, if you are viewing projections of account balances decades from now, using the 'real' setting will help strip out some of the displayed growth. For example, if a client currently has $1 million, showing them that they have $2.4 million in 30 years may make their eyes grow wide. But if that is a nominal value and inflation averages 3%, that is simply $1 million in today's dollars. Their balance wouldn't have grown at all in purchasing power terms (real dollars), only in nominal terms.

'Nominal' is helpful for historical examples

While 'real' is often a helpful way to view asset values, it isn't always the best. For example, if someone is viewing the Global Financial Crisis in the Retirement Stress Test, you might want to use the 'nominal' setting, particularly to view portfolio balances. After all, the clients likely lived through this period, and the amounts they would have seen on account statements would have been nominal, not real. This is even more true for periods when inflation was high, such as in 2022 or in the 1970s and 1980s.

Sometimes, when using the Retirement Stress Test, it may be beneficial to exclude inflation from the analysis to keep the calculation simple. If you switch to nominal, however, you will notice some interesting changes if you pay attention to how the light blue "Planned Income" evolves over time. For example, planned income that is 'flat' or steady in real terms will increase substantially in nominal terms during the Stagflation period.
 

Real View - Flat Income Path during Stagflation

Nominal view - Flat Income Path during Stagflation

The nominal view also contains inflation adjustments on the dark blue 'Income Experience' line. Notice how these stair steps serve to keep the income experience in line with inflation, reflected in the light blue shape.

How to change views

If you'd like to change the view you are using in the application, find the options menu in the upper right of the screen.

To see which view you are using, look for the guidance text at the bottom (Life Hub) or top (everywhere else) of the screen. If it says the values are in "today's dollars", you're on the real view. If it says "future dollars", you're using nominal.