Happy New Year! Now that 2006 is over, it’s time to see how our investments did last year. You can look up the performance numbers online or in newspapers, but if you bought or sold during the year, those numbers won’t match your own rate of return because the numbers online or in the paper assumes a) a single investment at the beginning of the year; and b) held until the end of the year with no additional deposits or withdrawals. Plus, in order to measure your progress toward your end goal, it’s more meaningful to get an overall rate of return on all your savings and investments, instead of returns for each investment. You want to know overall how you did during the year, when everything is taken into consideration, your 401k, IRA, regular taxable investments, savings accounts, treasury bills, etc., etc. Did you beat inflation? By how much?If you have detailed records for each buy and sell, you can gather them up and use the XIRR function in Excel or OpenOffice to calculate the precise rate of return. See this post by JLP for details. But if you have several accounts and you invest every month, getting all those numbers together will be quite time consuming. There is a much simpler way to estimate your rate of return. Here’s what you need for doing the estimate:
- Define your savings and investment pool
- Total balance in your pool at the beginning of the year (“beginning balance”)
- Total amount you put into your pool minus total amount you took out of your pool during the year (“net in”)
- Total balance in your pool at the end of the year (“ending balance”)
That’s it. Just 3 big-picture numbers. Ignore all inter-account transfers — sell one fund, buy another; buy stocks using money in saving account, etc. These all happened within the pool. Ignore all interests, dividends, capital gains distribution, unless you took them out of your investment pool. Ignore all fees and commissions paid from the money in the accounts. If you paid fees outside of your pool, count them in the “net in” number. Here’s the formula:
return = (ending balance - 0.5 * net in) / (beginning balance + 0.5 * net in) - 1
It’s very easy to remember. It assumes that your total net investment was invested 50% at the beginning of the year and 50% at the end of the year. Here’s an example:
Beginning balance: $100,000
Net In: $38,000
Ending balance: $150,000
rate of return = ($150,000 – 0.5 * $38,000) / ($100,000 + 0.5 * $38,000) – 1 = $131,000 / $119,000 – 1 = 10.1%
How accurate is this quick and dirty method versus the more time consuming XIRR method? For me, the difference is only 0.2%. You save a lot of time and get to focus on the big picture: How much did you contribute toward your goal (net in)? Did your savings and investments provide adequate return?
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