401K compound interest calculation

I sent Steve a copy of the spreadsheet I have on my personal site. FWIW, it allows entry for total percent going in, i.e. the sum of the employee deposit and employer match expressed as one number, for Steve, 10%. I don't compound monthly, we always talk here in terms of annual rate of return, and a 40 or so line sheet is easier to glance at in terms of changes to salary or impact due to a raise of the percent saved. Calculators that skip the 40 years' numbers and only show an end result are useless to my way of thinking, it's better to see the amount saved each year to tell if you're on track. For example - Given the numbers

JOE

Try

Joe, could you send me the spreadsheet... I was able to locate your site but the online version doesnt open in my browser...

Thanks. I have a side question on 401K calculation:

Sample year end report from fidelity 401k: Beginning Balance $22,448.69 Your Contributions $14,093.64 Employer Contributions $3,077.81 Change In Market Value $4,219.20 Ending Balance $43,839.34 Additional Information Dividends & Interest $3,099.13 Your Personal Rate of Return (for the year) 13.5%

What I dont understand here is how did they arrive at this rate of return? Also it seems that "Change In Market Value" include the "Dividends & Interest" value?

My confusion arises from the fact that my personal rate of return comes as 22% when I include last years figures. And I cant believe that rate of return on my investments!!

Please help me understand fidelity's "Rate of Return" or let me know good way to calculate that on yearly basis.

Thanks. Samsai

Making the simplifying assumption that your and your employer's contributions were evenly spaced through the year, your average invested amount for the year was: $31,034.42 = $22,448.69 + 0.5*($14,093.64 + $3,077.81). Your investment gain for the year was: $4,219.20 = $43,839.34 - $22,448.69 - ($14,093.64 + $3,077.81)

The rate of return on the average amount invested was 13.6% = $4,219.20/$31,034.42

This is just a simplified approximation of the real calculation to sanity-check Fidelity's calculation.

To do the real calculation one would need to know the exact dates and amounts of your contributions and your employer's contributions. With those in hand, one would then run the Internal Rate of Return algorithm on those cash flows (if you have Excel, you can load in its analysis toolpack and then you'll have access to the IRR() and XIRR() functions and can do the calculation yourself).

Thanks Rich and Joe... This was perfect explanation...

I will try to remember that this is continuous contributions type investment and hence the calculation is little different/ complicated...

I have heard that people try to achieve on a yearly basis 8% or more returns on 401K... they say if you maintain this rate of return over time, then you are on right path... since I started my 401K few years back, the market has been UP in general...

is 8% target achievable in bad years? I know it depends on the market, but experienced people can shed light on historic returns or share their experiences.

Thanks in advance.

- Samsai

assumption that your and your

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The simple answer is 'no'. This is a variant on the Risk/Return question. If you got 8% in a bad year, well, it wouldn't be bad, right? The 8% goal is achievable over time, I would think. The average return for the S&P has been over 11% for the past 40 years, and there's enough argument in favor of lower returns for the next 10-20. The 11.4% to be precise brought with it a 16.3% standard deviation. This simply means that about 2/3 the time the return was 11.4% +/- 16.3% and that 1/6 of the time, worse than -4.9% and 1/6 the time it was greater than 27.7%.

By diversifying, adding small cap, foreign funds, and bonds (this is not a complete list) you improve the return a bit, but more importantly, reduce the standard deviation. Modern Portfolio theory and specifically, the Efficient Frontier address this better than I can in one paragraph.