Did You Beat The Market, Mr. Investor?

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In my previous post, I wrote about the Beardstown Ladies who had to suffer public humiliation because they couldn’t tell what their annualized returns were.

In their defense, not many investors do know what their actual returns are!

Why? Because most brokers, don’t provide that information, including online portfolio managers like Google Portfolio and Yahoo Finance.

Don’t Confuse Return On Investment With Annualized Returns

Free Investor Tools
Let me give you an hypothetical example. If I invested $20000 and sold it all for $30,000 how did I do? Pretty good? That’s a 50% gain!

This 50% is what’s called Return On Investment. It simply tells you your overall gain (or loss).

Nice to know, but that’s not what you should be looking at when measuring portfolio performance. Why? Because in this example, I never told you how long it took me to make that money! What if I told you that I made this trade in 1999, got spooked, and have been sitting on this profit ever since?

Growth And The Time Factor

Growth and time factor
That changes everything! My annualized rate of return dwindles to 3.44%. That’s the effective rate.

That is, had I invested in say Treasuries or CDs (bank rates were much higher back then and prime rate was about 8%) that offered 3.44%, I would’ve made the same amount today without the stress and with no risk!

That’s why time value is important and ROI does not take that into account.

The 3.44% is also called the APY that we are all so familiar with. From an investor’s perspective that’s exactly what you should be looking at. If you put in a certain amount of money for certain number of years, what is your return? That’s your annualized return (also called CAGR- Compound Annual Growth Rate).

But when you invest in the stock market, you don’t make a single trade and sit on it for a set number of years. The deposits and withdrawals are spread out and at irregular intervals plus you have dividends, dividends reinvested, stock splits, taxes… no wonder brokers don’t want to do this!

The trick is to find out your APY or your annualized return taking the above into consideration. That’ll tell you how you really are doing.
photo

How To Find The Annualized Rate Of Return (APY) Of Your Portfolio?

Formula to calculate the annualized rate of return.
Annualized rate of return (true cagr) formula

Or you could simply use the FREE online tool I’ve provided to calculate the APY which looks like the read only view shown below.

Free online tool to calculate portfolio's annualized returns

What You’ll Need

  1. A copy of the APY spreadsheet. Click on File..Make a copy for an editable version of this tool. (If this menu is greyed out, make sure you are signed in to Google – top right ‘Sign In’ menu)
  2. Your portfolio value as of the start date from which you wish to calculate APY. You can pick any date
  3. The current date and the ending value of your portfolio as of this date
  4. All cash deposits and withdrawals during this period along with their dates

Howto Calculate The Personal Rate of Return or APY

  1. Enter the beginning date and value of your portfolio in the first row as a negative number. This should include cash plus the market value as of your investments as of that date
  2. Enter the current date and value of your portfolio in the last row as a positive value
  3. Fill out any cash deposits(negative) and withdrawals(positive) during this period
  4. Don’t leave blank rows. Delete by right clicking on the row and selecting delete. You can insert additional rows using the same technique
  5. The APY is automatically displayed in the final cell!

What About Taxes And Dividends?

Glad you asked! Taxes are entered as a negative number. Don’t include dividends unless you withdraw them. If left as cash, it is a part of your overall portfolio value. Never include dividends reinvested.

I’m Confused With What’s Positive And What’s Negative!

Focus on your pocket! If cash goes out, that’s negative. If cash comes in, that’s positive. Your initial amount is the cash you paid to purchase your assets in your portfolio, hence that is negative. The final amount is the cash you would’ve withdrawn had you sold all your securities, so that’s positive. If you withdraw dividends, that’s money coming in; enter that as a positive value. When you pay taxes, capital gains or for the dividends, that’s money going out of your pocket and that should be entered as a negative value.

There you have it! Now how did you do compared to the S&P 500?

The Moment Of Truth!

Here’s how the market did for the past 1, 5 and 10 years. How did you do?

 
1 Year
5 Years
10 Years
S&P 50014.322.171.31
You!

Did you beat the market Mr. Investor?

Recommended Read: 10 Questions You Must Answer To Stay On Top Of Your Portfolio


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25 thoughts on “Did You Beat The Market, Mr. Investor?

  1. Good post! Everybody should calculate or at least know their performance. If someone is managing their money they should know their performance. I agree with you that most people don’t! They see their account is up $5,000 this quarter and figure they’ve done fine when actually it could be horrible performance.
    Schwab actually has started a tool that calculates performance and compares it to a model benchmark which I described in this post:
    http://rwinvesting.blogspot.com/2011/01/how-can-i-calculate-performance-of-my.html

    • I hope others follow Schwab’s lead! I’m sure Fidelity will!

      • Whether or not others follow I think depends on whether people ask for it. I talk to a lot of people who have no idea of how their investments are performing. When the market is up they see their statement value has increased and they are happy and when the market is down they are afraid to open their statement. Go figure!

  2. This is a great point and oft-overlooked. I think it is convenient to think of total ROI, but that certainly is not the only important measure to be evaluating.

    • Since most brokers don’t provide this info, the onus is on the investor to find this out in order to a have a realistic picture of portfolio performance.

  3. Hi Money cone, You reminded me that my old 15 year Quicken files became corrupted about a year ago. Thus, I can only calculate my actual return for about the past 8-10 months! ( Fortunately, for those prior many years I was quite on top of our personal portfolio.)
    I totally agree with the topic. But as a caution, don’t get too concerned about short term returns (less than 5 years). As long as you continue to save and invest, your money will likely grow over the long term.

  4. Thanks for putting this spreadsheet together. It is also important to note that annualized does mean a one year period. I currently don’t have my returns annualized for my College Investor portfolio because it hasn’t existed for a year yet.

    If I did annualize it, the return would be 53.10%!

  5. The publisher of the Beardstown Ladies should be the one feeling the humiliation and shame. No editor worth their salt should have let this one slip past them. I like looking at 10 and 15 year rates of return at a minimum.

    • Exactly! How could let something like that slip by? And they put the returns on their cover!

      The publisher wasn’t a small town publisher but Hyperion, a division of Disney!

  6. Very good post, Money Cone. It’s a good intellectual excercise for people to really stop and understand their true returns, considering multiple variables. I’ve always suspected that many people not attuned to personal finance tend to not to consider such things as annualized returns, time value of money, etc.

    • Doing this exercise is enlightening. Makes you realize how hard it is to beat the market in the long term. And why any short-term fantastic returns mean little when time is factored in.

  7. Great writeup on the topic.

    Shoot, “DIY Investor” stoled my thunder… I too, was going to mention that Schwab does the calculations for you.

    I pretty sure you are right about most people don’t know this stuff. Unless you took finance or accounting classes in college, this stuff is cryptic, to say the least…

    Luckily, I have a minor in business in those areas. I really enjoyed my finance/accounting classes :)

  8. This is an incredibly useful tool! Annualized return is one of the most misunderstood aspects of investing, and calculating it can be a daunting task. I think this spreadsheet will allow people who may not have previously calculated their returns to do so. Great job!

  9. Excellent post! Can’t say if I beat the market, but at least now I can say I have the tool to correctly figure it out. This seems more accurate because of the all critical time factor. Should we get rid of ROI because it is semi-misleading?

    • Now you are talking like a credit card company Buck! They always want you to think in terms of your minimum payment, not what you’ll actually be paying if you bought an item for say $2000 at 18% APY.

      You’ll be paying 2,423.22 in interest alone, that’s a ROI of 121% for the cc company! They lent you $2000 and got back $4423.22.

      The above example takes both ROI and APY I discussed in my post, into account. This gives you a frame of reference.

      Use a similar analogy for your investments as well.

  10. Great post. Made me think that I need to take a closer look at our portfolio and at least pay attention to what’s going on. I let it slide all the time unless economic times are rough.

  11. Good detailed explanation of returns, MC.

  12. Loved the post for its detailed explanation.

    As for beating the market, the past doesn’t matter as the challenge at hand is the current year!

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