Calculating Return on Investment

Question: Is there a quick way to calculate an estimate of the overall investment performance of my retirement plan account? I know there are lots of places to get performance figures for individual mutual funds, but how can I calculate how I am actually doing with my overall retirement account? I would like the answer to take into consideration my asset allocation, the switches I have made, loans, etc.

Answer: The latest version of the quarterly participant statements actually tells you what your time-weighted estimated rate of return was for the quarter.  In addition to that there is a really quick way to calculate your overall Return on Investment ("ROI"). The formula below estimates your investment performance and it reflects the way in which you have actually invested in the various mutual funds (i.e. your asset allocations at various times and transfers you have made between funds during the period, etc.). The formula is:

 Where do you get the data for this formula? You can get all of the data you need from your printed quarterly participant statements. If you want to do the calculation for just one quarter, then everything you need is on that one quarterly statement.  For the Investment Gain figure, use the dollar amount shown on the "Total" line under the column "Gain or Loss". For Beginning Assets, use the amount shown on the "Total" line under "Balance" for the beginning date. For the Ending Assets (shown in the "Balance" column for the ending date), be sure to use the total balance and not just the vested balance if that is different. When you have a copy of your statement in front of you, this will make sense. Use the figures from the "Total" line. Do not use any of the figures for individual mutual funds. You want to measure your overall ROI and that is why you use the Total line. If you want to calculate your ROI over a longer period, then you will need each of the quarterly statements spanning the desired period in front of you. Suggestion: Always keep all of your quarterly statements in some organized place for later reference.

For example, let’s suppose you want to calculate your overall return on investment (ROI) for a six-month period. In that case, you will need your two quarterly statements spanning that six-month period. Get the Beginning Assets ("Balance") from the earliest statement (e.g. 1/1/98 Balance). Get the Ending Assets from the latest statement (e.g. 6/30/98 Balance). For the Investment Earnings for the entire period, add together the amounts shown on the "Total" line for the "Gain or Loss" column from each of the statements.

This formula is reasonably accurate if new money is being added to the plan on a fairly uniform basis throughout the period you are measuring. This is generally true, of course, for 401(k) plans because salary deferrals are put in each pay period or each month. The formula can be somewhat less accurate if there are any substantial special deposits (substantial in comparison to the beginning balance) made only near the beginning or near the end of the period. Some examples of such deposits would be rollovers from another plan, large matching contributions or company profit sharing contributions. The smaller the deposits are in comparison to the beginning balance, the more accurate the formula is.

The ROI that is calculated using the formula above would even take into account participant loan activity, if any. When you take a participant loan, you are allocating part of your investment assets to an "investment" that is going to earn whatever the loan interest rate is. If this loan interest rate is lower than what investment choices are earning, then you are lowering your overall ROI for the period.

If there are significant deposits or withdrawals going on during the measurement period which are not uniform in amount or in timing, then you would need some specific software to calculate your ROI instead of using this simplified formula. We have an Excel spreadsheet we have developed for that purpose, but it does take some time to gather all the information to run it and for the great majority of participants the quick formula above gives approximately the same answer for overall ROI.  If you want to run the relatively precise calculation for a the current year, first retrieve your transaction history for the year.  Then enter that data into the following Excel template:  ROI Calculator

How well you do with regard to investing your retirement plan assets is extremely important. A small difference in actual investment rate of return can make a very big difference in how much money you accumulate.   It is a good idea to measure how well you are actually doing. Just knowing how the underlying investment options are performing is an indication of your performance, but using the formula above helps you understand how you are doing based on your specific asset allocation and any transfers between investments that you have made.

Sometimes after a participant calculates their ROI by using the formula above (or in some other manner) they compare the results to some published ROI statistics for the investment options they are using.  Often the results are dramatically different which leads to a feeling something is wrong.  For example, let's suppose a participant calculated their ROI for some specific investment option - for illustration purposes, let's call the investment option  "Big Company Growth".

The published results for Big Company Growth would be for a specific period of time.  For example, the ROI for the entire Calendar Year of 1998 might be listed as +20%.  Suppose this participant is only using this one fund in their retirement plan and their calculation of their ROI  for 1998 is only 12%.   It seems like something is definitely wrong.  The difference comes from the fact that the participant's actual ROI is the result of much more than just their balance at the beginning of the year.  The participant would have added money throughout the year and as he or she added money, units or shares in the fund were bought at different prices. 

The participant's account balance at the beginning of the year would have earned the same 20% as the investment option.  But the units bought during the year at various prices would earn some different ROI.  If the unit prices of the mutual fund went up during most of the year and then decreased significantly near the end of the year, then the participant additions and purchases during the year would have made less than 20% or even lost money depending upon when the units were purchased.  The participant's overall ROI would be a combination of his or her money at the beginning of the year and the investment performance of all of the money added during the year on a weighted-average basis. 

This overall ROI will probably never exactly equal the performance of the investment option for the year because the performance of the investment option is based upon only money invested at the beginning of the entire year and not deposits made during the year.   If you would like a numeric example of how this happens go to the example we have prepared:  ROI_EXAMPLE

If you have any questions about this material, please call our office and ask for Paul Carlson. The phone number is (650) 341-3322.