A very popular retirement vehicle is the 401k. In fact, as of April 2014 there were more than 638,000 401k plans in place with nearly 89 million Americans participating (according to the American Benefits Council).
If you are one of the large number of people using a 401k as your primary retirement investment vehicle, you must learn how to determine the actual performance of your 401k, and do so regularly. Then you’ll be able to have some assurance that your investment choices are working. However, it is not as simple as looking at the end value of your investments for the specified timeframe and comparing it to the figure at the beginning of that period. You could be misled doing it that way.
There are multiple factors that go into the 401k performance evaluation equation. Specifically, you need to know:
- How much you contributed in the given period (e.g., 12 months)
- How much your company matched (e.g., 100% match of first 5% invested)
- What dividends and capital gains were received
- How much a mutual fund actually grew in value.
Let’s take a look at two simple scenarios to understand how these 4 factors work together:
As you can see in these two scenarios, the return on investment (ROI) is quite different even though the market value is the same. The percentage return for Scenario A is 22% while the return for Scenario B is 11%. Even though the portfolios have the same market value, the person in Scenario B contributed more money to the investment, lowering the rate of return.
Once you know the real return on your holdings, you can compare it with a benchmark such as the Standard and Poor’s 500 to see how your investment mix is faring against a broad market index. Of course, this comparison alone won’t be the sole determinant for whether you are receiving an appropriate ROI from your 401k. Your long-term investment goals, age, and risk tolerance also play a part.
So, we hope this information helps you to understand the real ROI in your 401k. It’s crucial that you know that before you take additional steps such as changing your investment mix, or making contribution adjustments. If you have any questions or want further information on this topic, please contact us.
In an upcoming post we will look at determining what your target percentage return on your investments should be in order to retire as planned.