Explanation

Real return is the most appropriate measure for assessing the increase in purchasing power of a portfolio's value over time because:

1. Purchasing Power Adjustment: Real return adjusts nominal returns for inflation, which directly measures how much more goods and services the portfolio can purchase after accounting for price level changes.

2. Comparison with Other Measures:

   • Holding Period Return (Option A): This is a nominal return that doesn't account for inflation. It shows the total return over a period but doesn't reflect changes in purchasing power.
   • After-tax Return (Option B): This accounts for taxes but not inflation. While important for net returns to the investor, it doesn't measure purchasing power changes.

3. Formula: Real return is calculated as: $\text{Real Return} = \frac{1 + \text{Nominal Return}}{1 + \text{Inflation Rate}} - 1$ Or approximately: $\text{Real Return} \approx \text{Nominal Return} - \text{Inflation Rate}$

4. Investment Decision Making: Investors should focus on real returns when evaluating long-term investment performance because what matters ultimately is the increase in purchasing power, not just nominal dollar amounts.

Example: If a portfolio earns 8% nominal return and inflation is 3%, the real return is approximately 5% (8% - 3%), meaning the portfolio's purchasing power increased by about 5%.

Reference: Module 1.3, LOS 1.e - This learning outcome covers different return measures and their appropriate applications in portfolio management.