Investing in a 401(k) plan can be invaluable in saving for retirement. To make sure that you're on track to achieve the results you want when you retire, it's important to look at your performance periodically. Calculating your average annual return is a good way to see how you're doing compared to major stock market indexes and other key investing benchmarks. Below, we'll take you through a step-by-step process to calculate and assess your 401(k) performance.
Measuring true growth
The first step to coming up with an average annual return is to figure your total return. That calculation would be simple, except that you'll typically make regular additional contributions to your 401(k) account over time. You therefore can't simply take the ending balance and divide it by the starting balance.
Instead, take the ending balance and subtract out any contributions you made since the beginning of the period. Then divide by the starting balance. Subtract 1 and multiply the result by 100, and that will tell you the percentage total return.
Take your time
If you've measured a one-year period, then you're done: the answer you got above is your annual return. But if you've used a period other than a year, there's some more math involved.
For periods other than a year, you'll need to take the number you got by dividing the adjusted ending balance by the starting balance and then use an exponential calculation. For a two-year period, you'll need to take the square root, which on a calculator involves using the power key to raise the number to the 1/2 power. For a three-year period, you'd raise it to the 1/3 power, and so on.
Then, take the final answer, subtract 1, and multiply the result by 100. What's left is the average annual return.
Keep in mind that the longer the period of time you're measuring and the more added contributions you've made during the period, the less accurate this simple calculation will be. A more sophisticated calculation would use a time-weighted account balance to calculate the percentage rather than the starting balance. For most situations, however, both methods will produce results that are reasonably close to each other and that reflect your performance well.
A 401(k) isn't the only retirement vehicle you can use; consider your IRA options, too, and figure out which one might be right for you.
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