I believe that that most investors don’t know how to calculate their account performance, and even the ones that DO know how, do not know if that performance is good or bad. Therefore, they answer my performance question with a vague statement that reflects how they “feel,” rather than an accurate answer about how their money is performing.
My goal is to teach you the process behind the calculation, but please do NOT use my “back of the napkin” method as a replacement for your statements or your performance reports. This is “in general” how to do it.
Step one – determine what dollar amount was invested. Although this step sounds easy, it involves calculating an adjusted cost basis that will need to include any deposits/withdrawals. For example, if you began with a $100,000 investment, but withdrew $20,000 during the year, then your remaining cost basis is only $80,000. For a perfectly accurate number, the exact date of the deposits/withdrawals needs to be considered, but for purposes of a general calculation, this method will do.
Step two is to compare the cost basis to the current value. If the current value is $86,500, then the gain is $6,500, or 8.13% ($6,500 divided by $80,000 cost).
Next, you will need to spread the returns over the time frame with which the money has been invested. In the example above, we know there was an 8.13% return, but over what time frame? One year? Ten years? This needs to be calculated. We’ll assume a 2 year time period.
Once these variables are known, you can manually calculate the numbers (as shown above) and divide the performance over the number of years, or use a financial calculator to be more precise. I like the calculator, so we shall go with that. Be sure to view the assumptions in the fine print.
Present Value (PV) = $80,000
Future Value (FV) = -$86,500
Number of periods (N) = 2 years
Solve for I/YR*
The answer is 3.98% per year. Is that good or bad? It is a trick question because it depends on the level of risk you are assuming, and the performance should be compared to a benchmark.** To compare a conservative portfolio to a 100% stock index is like racing a Volvo against an F-16 fighter jet. If you are investing safely, then it is irresponsible and misleading to use a stock index for comparison purposes. However, once you have something fair to race your account against, a decision can be formed about the account performance.
*Assuming 1 payment/year. Either the PV or the FV needs to be negative for purposes of the calculation.
**Seek the help of a professional to determine an appropriate benchmark.
Past performance is not a guarantee of future results.