Rate of return question

[SMB]

Hi all,

I have a question about the personal rate of return listed on the quarterly statement for my retirement plan.

My beginning balance was 18,684.42 at the start of the quarter. I made 1,200.00 in contributions; in addition, the account value changed 1,190.07. I had fees of $4.49. New balance: 21,070.00.

At first, I thought I'd doubled my money (account value changed 1190.07 on top of my contribution of 1200), but then I saw that my personal rate of return was 6.2%. I can't wrap my mind around how that might be so, and I wonder if I'm missing something obvious. Can someone please demonstrate the math that calculates the personal rate of return?

I know the market hasn't been that great lately, but I'm doing all of my retirement planning on an estimated 10% rate of return, and I need to decide if I have to make some adjustments to my allocations.

Thanks!

Sharyl

[sweeps]

Re: Rate of return question

You earned your return on the total principal ($18,684.42) plus the average of your contributions during the time period (roughly $1200 / 2, or $600). That's a total of $19,284.42.

So the rate of return is $1,190.07 / 19,284.42 which equals .0617 or about 6.2%.

[SMB]

Re: Rate of return question

Now I get it. Now that I understand how it's calculated, the only change I would make to the math above is 1200/3 (it was a three-month period) which equals $400--then the rest of the equation equals 6.2 exactly. Thanks so much for clearing it up for me.

One more question, if you don't mind: Is 6.2% considered too low for a personal rate of return? I know (after doing a little research since my initial post) that it can appear lower than expected due to dollar-cost averaging, but I'm not sure what to shoot for (whether 10-11% is "too ambitious" for a personal rate of return, in other words).

Thanks so much for your help!

[34saving]

Re: Rate of return question

Anybody who can consistently make 10% year after year is doing VERY VERY well IMHO.

[sweeps]

Re: Rate of return question

You don't (necessarily) want to divide by 3. At the beginning of the quarter, you had $0 in contributions. At the end of the quarter you had $1200 in contributions. Assuming you contributed regularly to your account ($400 at the beginning of months 1, 2 and 3), you can take the average of the beginning and ending and come up with $600.

However, if your contributions were made differently, that could change. For example, if you contributed the full $1200 at the beginning of the quarter, your average contribution would be $1200.

6.2% return in just 3 months is fantastic. That's almost a 25% annual return! The question is... what are you invested in and what is your risk tolerance? If you're invested in very risky investments, you may have some big swings up and down.

It seems most advisors think 7%-9% is a more realistic long-term return. 10% or 11% is probably not a reasonable estimate.

[jmjj215]

Re: Rate of return question

Anybody who can consistently make 10% year after year is doing VERY VERY well IMHO.

Hear hear.

[SMB]

Re: Rate of return question

Well thanks, folks. I'm still trying to wrap my mind completely around it, but it's definitely more clear to me now. (To answer your question, Sweepsplayer, my portfolio comprises 80% stocks, 20% bonds. I'm comfortable with a bit of risk since I'm still fairly young, but the 6.2 took me by surprise. I've been doing some reading on personal finance and I seemed to keep seeing "10%" as something to shoot for. Maybe I misunderstood.)

Thanks again, all!

[baselle]

Re: Rate of return question

You didn't really misunderstand - that 10% figure is taken as an average return based on 70 years of stock market results, booms and busts. It means that that one fantastic year is going to have to make up for years and years of dips and flat returns.