Retirement Planning: Personal Rate of Return

[naaman]

I'm looking at my 401(k) and I see that my year-to-date personal rate of return is 6.20%. I am currently contributing 6% of my base salary (payroll will only deduct from the first 40 hours I work) with a company match of 75%. I'm maxing the company match.

Is 6.20% a good rate of return?

Also, does rate of return change with the amount I contribute? For example, if I up the contribution to 7% would I see an increase in the rate of return (a partial percentage point or so), or just an increase in the net return? I will be getting a substantial raise in October at which point I am planning to increase my contribution percentage. I have about 30 years left before retirement the way I'm planning it now.

Thanks in advance!

 

[docjohn]

does your plan allow you to buy individual stocks or just mutual funds? do you have many funds to choose from? and who chooses them? Do you know what fees are taken out?

 

[naaman]

Yes. I am not fluent in investing or the stock market, etc, so I have it set up to allow an "expert" to make those choices for me. It costs me $12.50 per month. The plan is designed to be more aggressive in the earlier years and gets more conservative the closer I get to my target retirement date.

Most of the revenues I see are only a few cents at a time (and sometimes is a loss). The biggest "profits" I get are from the company match, obviously. But the option exists to manage it myself, if I so choose. But like I said, I just don't know enough to feel comfortable making those decisions right now (and don't have time to do the reseach at this chapter in life).

 

[docjohn]

most "experts" try to do better than the S&P nasdaq and dow...your 6.2% is certainly better than any CD or bank would give you.....but you are lagging behind the indices.This market has been strong of late.You should have a sitdown with your plan adviser to discuss these things.There are short term corporate bonds and some high dividend telecom stocks that yield a 7-8% ......so my short answer is if you care enough to post then you need to begin to educate yourself .

 

[naaman]

Touche!

I guess I'll just have to sit on it the way it is for now. With a full load at school, and 55-60-hour work weeks (plus wife and kids), I have more immediate priorities than retirement. I may be able to take a relevent class next semester, though...

 

[relapse]

Disclaimer: I do not claim that I know more about retirement than the next guy. I'm just giving you a data point.

I logged into my 401(K) savings plan and see 13.5% year-to-date and 16.2% as a 5-year rate of return. I'm also in the same boat as you: 30+ years until retirement with a wife and kid. I was curious how Vanguard calculates rate of return and this may answer one of your questions in your original post:

• Calculation method. Personal performance uses a formula called internal rate of return (IRR), which is a dollar-weighted return. IRR takes into account new money coming into your investment, as well as how long that money has been held. Don't confuse your personal rate of return with those posted for funds and indexes. The returns presented in these instances use a time-weighted calculation, which does not take cash flow into consideration.

So according to the above, at least with Vanguard, rate of return does change with the amount you contribute. I don't know how your 401(K) plan works, but have you looked into Target Retirement Funds or Target-date Funds? There are pros and cons with this approach but it may be something to consider.

 

[naaman]

Yes, I am using a target date program to "strategize."

What I am wondering is how my contribution amount affects the rate of return (if at all).

The definition you posted leaves me somewhat confused because I do not understand the meaning of "dollar weighted return" in the given context. Also, I'm not sure whether "cash flow" refers to the contribution amount or the fluctuation of values in the market.

 

[relapse]

Here's a pretty good explanation that I found: http://finance.zacks.com/401k-personal-rate-return-calculated-11372.html. If I interpreted this correctly, your contribution does affect your personal rate of return. Anyone, please feel free to correct me.

 

[sahtt]

There isn't sufficient information here to answer your question. Returns are most accurately measured in risk adjusted terms; with no context as to what you are invested in and what tactics may be involved, we cannot tell you if x% returns are 'good' or 'bad.'

In reality it is likely irrelevant for the time being; you said you don't have the knowledge (yet) to make intelligent decisions in the field so even if the results were way behind an appropriate benchmark I doubt you'd change anything short-term.

The best strategy for inactive investors who are not overly familiar with the markets and risk is to invest systematically in high quality indexes with a flexible and professionally designed allocation.

My 401k has limited options; I have a slight majority in the s&p 500 and am overweight frontier nations, specifically small caps. In my individual and ira's I own primarily individual equities.

- - - Updated - - -

Contributions should not impact rate of return. I only skimmed the article but the example I read agrees. Only the gain or loss on contributions, be it by you or the firm, impact rate of return.

It is a separate, but still important, calculation to determine the overall impact of the employer's contributions to the account balance.

 

[docjohn]

your rate of return should be independent of the amount you contribute.....the timing of those deposits and when they get converted into funds or stocks is more important.....my disclaimer is I'm an amateur...

 

[relapse]

Ahh, I see. I stand corrected. If contributions don't impact rate of return, then damn, my 401(K) is doing much better than I thought.

Here's an example that support sahtt and docjohn mentioning that rate of return is independent of contributions. In the simple example cited on http://finance.zacks.com/401k-personal-rate-return-calculated-11372.html:

Beginning balance = 5000
Contribution = 3000
Ending balance = 8800
Total annual return = Gain/Ending balance = (800/8800)*100 = 9.09%

However, let's say the contribution amount is instead 1500 and hypothetical "market growth" is the same.

Beginning balance = 5000
Contribution = 1500
Ending balance = 7150 (since in the above example, (Beginning balance + Contribution) * 1.1 = Ending Balance, so in this case we get (5000 + 1500) * 1.1 = 7150)
Total annual return = Gain/Ending balance = (650/7150)*100 = 9.09%

You can see that the annual returns are the same. Hope that helps.

 

[naaman]

Okay. I see. I will probably look more deeply into this after I finish school next summer. In the mean time, I'll just increase my contribution along with my raise.