One of the most significant numbers in determining your portfolio’s success is its “rate of return”. What we find in our practice is that most people don’t know it, or they’re calculating it incorrectly.
Your rate of return usually indicates the return your investments have generated on an annual basis. Typically an investor who is actively contributing or withdrawing from an account will include these contributions or withdrawals in their overall return.

Here’s an example:

For example let’s say you have an IRA with a balance of $100,000. If you contribute $14,000 during the first year and see your account balance at the end of the year at $117,420, it’s easy to believe your portfolio returned 17.42%. What most people don’t take into account is the amount they contributed. In this example, with an annual wrap fee of 1%, your portfolio only returned 4% and you only benefitted from 3% of it.

What about fees?

In this instance, the 1% fee charged on an annual basis was taken from the balance of the account. You must also consider front end and back end fees. If there is a 5% back end sales load and you hold the investment for 5 years- that could mean another 1% taken away from your “annualized returns”, depending on the performance of the fund. The longer you hold the fund, the smaller the annualized impact it will have.

How about taxes?

Your annual return on investment accounts can be reduced by taxes as well! Let’s say this money is not held in tax advantaged vehicle such as a 401k, IRA or Roth IRA. Your return could, again, diminish from paying capital gains taxes bringing your annual return under 3%. Going from an annual return of 17.42% to under 3% is a pretty dramatic jump.

Annualize Your Rate of Return

If you’ve held an investment for a number of years, do you know your annualized rate of return? We recently had someone who had owned an investment since 1998 and they hadn’t contributed an extra dollar to it. Their overall return was 15%. Being up on your investment 15% sounds good until you annualize that rate of return. Take 15 and divide it by the 18 years they owned the investment and what it figures out to is .83% annually. The question then comes to mind – are you even keeping up with inflation at that rate?
You may find that, while you have the warm fuzzies about your portfolio now, after calculating the annualized return over the years, you’re not doing as well as you suspected.
If you would like help calculating your annualized rate of return or understanding the fees you’re paying, come in and speak with an advisor.