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Question From a Reader – Calculating Personal Rate of Return
By JLP | January 16, 2007
I received the following question from a reader:
JLP,
Thank you for your site. I have found you present topics in easy to understand ways and also bring to light other sources of information that do the same.
I was reviewing your post on personal rate of return and I wanted to ask a question about 401Ks and personal ROR. In calculating your personal rate of return would you include company matching funds as part of the contributions? I could see it both ways, as the company match can be seen an immediate return OR the true returns are on the various investment vehicles you select within your 401K.
My response:
Yes, you should include any matches in the calculation. The purpose of the personal rate of return calculation is to see how your investments are performing. If you don’t include the employer match in the calculation but still use the same ending value, which includes the company match, you will overstate your personal rate of return.
For example, using the formula I found over at FinanceBuff’s blog, you can calculate your personal rate of return (PRR)…
2006 Beginning Balance of $50,000
2006 Contributions of $6,750 (of which $2,250 is company match)
2006 Ending Balance of $64,000
Step 1 – Take the ending balance and SUBTRACT half of the amount contributed:
Step 2 – Take the beginning balance and ADD half of the amount contributed:
Step 3 – Now, to find your PRR, divide the answer found in Step 1 by the answer found in Step 2. Then, subtract 1 from that answer:
Now, perform the calculation again but EXCLUDE the company match of $2,250, and you’ll get a personal rate of return of 18.18%. Sure, it sounds good but it isn’t realistic in this case since a good portion of that “return” wasn’t from actual investment growth.
Anyway, I hope this helps. I’m curious to hear what you guys think.
Topics: 401(k), Investing, Personal Rate of Return, Retirement Planning | 3 Comments »
January 17th, 2007 at 8:20 am
Mathematically you are indeed correct not to include company match.
On the other hand the company contribution is in fact part of the total return since you did not contribute from your pocket. Including company contribution also will help provide added incentive to save in your 401k since it will show you how really good your returns can be.
I just saw a news item that stated that the median retirement account balance was about $60k. Anything that can be done to encourage people to save in their 401k’s can help to increase that number.
November 6th, 2007 at 2:18 pm
I was wondering how Fidelity actually computes their rate of return, when viewing your online statements. I can’t seem to make any of the formulas on this site come up with the same percentage that Fidelity does. Can you please help?
December 11th, 2007 at 2:42 am
Nearest I can tell, Fidelity subtracts company matching funds from both sides of the equation to get their number:
PRR = [ (end_bal - company_match) ]
[ ------------------------- ] – 1
[(beg_bal + your_contributions + loan_payments)]