What is the method for gauging the success of a retirement plan when funds are deposited with varying amounts?

Question

I get quarterly reports on my 457(b) plan. I almost always have gains, however, I am unsure on how to determine if the investment options are strong earners, or merely mediocre. What is the process for determining if the investment's I've chosen are strong when the option amounts change due to varying bi-weekly contributions? How would I determine if the gains are good in the following example for one quarter?
Example:
Beginning Balance: $5,011.33
Contributions / Transfers In: $370.00
Gain/(Loss) / Interest: $136.68
Ending Balance: $5,518.01

Since starting in 10/02 I have contributed $3993.00 and had gains of $1525.01. However, the contribution amounts have varied greatly over this time period. So what is the proper gage on success? At 35 years old, my investments are diversified between high and moderate risk with some low risk mixed in.

Answer 1

All you need for this calculation is a simple calculator. You have the beginning and end balances and know how much you put in and/or take out. Just think of your account as a balloon. You have inputs to make it expand and internal money generation (gains) that also make it expand.

Assuming your ending balance is as of today, and your opening date is 10/2002, then your return can be calculated as follows:

((gain)/beginbalance)
or
(1525)/5518=.276 for a roughly 5 year and 9 month period.
Annualized this is
.276*12/69=4.8%

Based on the rough approximation, this is a very poor return on your investment, if I my assumption on your starting date is correct.

If you care to run your own analysis and know your cash flows both in and out, then XL has a good IRR calculator or you can use...

http://www.datadynamica.com/IRR.asp

The answer will be more accurate, but the above calculation will be within a 1/4% accuracy.
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Answer 2

Go into Microsoft Excel and if you can, input the contributions and if you have withdrawn anything the withdrawals.

Now, if the dates are regular but the amounts are not, you can simply treat the dates as 1,2,3,4,5,6; but if the dates are substantially irregular, you need to make a spreadsheet of days with one row per day.

Unless it is highly irregular pay, go with even periods even if you are paid semi-monthly rather than bi-monthly.

Make each contribution a positive amount. Take the final balance at the ending statement and make it a negative number.

Highlight all the cells and hit insert function and insert IRR, or Internal Rate of Return.

If there have been no cash outflows IRR performs the calculations correctly. If there have been cash outflows, make them negative values and there will be one answer for every withdrawal and it gets too complicated to explain on the net.

This will tell you your rate of return.

You can then compare this to your personal needs. If the return is adequate then you have been historically fine, if not, you should look at redoing your portfolio.

Answer 3

This is where an "index" comes in handy. An index is a measurement of a certain section of the stock or bond market. A research group will pick a bunch of stocks and follow their price movements and dividends, calculating a total return. Then, mutual funds can compare their returns to their respective index.

For example, the S&P 500 index measures the 500 largest stocks in the U.S. So, large-cap mutual funds will compare their own returns to that of the S&P500 index.

Unfortunately, the research has shown us that most mutual funds cannot beat their respective indexes over long periods of time. This is why a low-cost index mutual fund beats 70 - 80% of actively-managed funds over a period of 10 years or more. Most actively managed funds actually underperform their index because of unecessary high costs.

Check out http://www.morningstar.com to find info on your mutual funds ... assuming these are regular mutual funds and not a variable annuity. You may not be able to find good info on variable annuity mutual funds on the morningstar website.

For a free downloadable book on retirement investing, check out http://www.invest-for-retirement.com

You will know that you have good mutual funds if they are of low costs. Past returns mean absolutely nothing for predicting future returns. Costs are a much better predictor of future returns, and the academic research shows this time and time again.