Monday, 16 April 2012

How to figure your portfolio's return

Q: How can individual investors calculate the rate of return on their portfolios if they have deposited or withdrawn money from the account?

A: I'm always intrigued when people do things with their investments they'd never do with their money in normal life.

Would you order a dish from a restaurant menu without knowing the price ahead of time? Would you buy a non-refundable airline ticket without knowing the fare? While there may be some exceptions, the answer will usually be no.

But investors keep buying stocks, bonds and mutual funds and have no idea what they're paying or, more important, getting in return. And they may be paying dearly either with large mutual fund fees or indirectly with lackluster performance.

Worse yet, they might be fixated on their one winning stock while ignoring the five dogs that are killing their portfolio.

Are you one of these people? You are if you don't know how to calculate the return of your portfolio. You'd be surprised how many people don't. The briefly famous Beardstown Ladies investment club thought they were brilliant investors until it was discovered they were not measuring their returns properly (they counted deposits to the account as investment returns).

Many brokers don't help. Few of them bother to provide rates of return for their customers' portfolios. The cynic in me suspects that if many active traders knew what their real returns were, they'd probably quit trading so much. To the credit of major mutual fund companies, most of them do calculate your performance data.

Well, it all gets cleared up right now. I'll show you how to do this yourself, using 2005. To get started, you'll need:

1. The balance of your portfolio on Dec. 31, 2004, available on your statements.
2. The portfolio balance on Dec. 30, 2005.
3. The dates and amounts of any deposits or withdrawals made during the year.
4. Unless you're a math genius, you'll need a financial calculator or Microsoft Excel.

Let's say your portfolio was worth $10,000 on Dec. 31, 2004. During the year, you deposited $1,000 on March 30, withdrew $500 June 30, deposited another $1,000 Sept. 30 and the portfolio ended the year worth $12,000.

Someone who didn't account for the deposits and withdrawals would assume they did well last year. After all, the portfolio gained 20% in value, not including the value of the deposits and withdrawals.

But let's do this correctly. We'll first do the problem assuming you have a Hewlett-Packard 12C financial calculator, a popular calculator handy for all investors. Incidentally, the calculator is celebrating its 25th anniversary. You can read more about it here.

Keep in mind that each number described above is actually a cash flow. We can plot it this way:
Initial cash flow: minus $10,000. We show this as a negative number because it's theoretically money coming out of your pocket to invest.

Cash flow 1: minus $1,000 — again, a negative number because the money is coming out of your pocket.
Cash flow 2: plus $500. This is positive number because the cash is coming into your pocket.
Cash flow 3: minus $1,000. Negative, see above.
Cash flow 4: plus $12,000. This is the money theoretically coming into your pocket from the investment.

The HP 12C makes this easy to calculate. Here are the keystrokes (note the "CHS" key makes the number negative):

Step 1: 10,000 CHS [g] Cf0
Step 2: 1,000 CHS [g] Cfj
Step 3: 500 [g] Cfj
Step 4: 1000 CHS [g] cfj
Step 5: 12000

Now that you've entered everything, all you have to do is hit the [f] IRR key, and the calculator does the rest. The HP12C will show you that the quarterly return on your portfolio is 1.14%. All you have to do is annualize that quarterly return. To do that, divide 1.14 by 100, add 1, take the sum to the fourth power, subtract 1 and then multiply by 100. You then derive an annualized return of 4.639%.

You might be proud of yourself until you realize that last year, the Standard & Poor's 500 index returned 4.9%, says Ibbotson Associates. In other words, you underperformed a basket of stocks that a monkey could have bought and held in an index fund. And that doesn't even include any taxes you may have paid if you sold any of the shares for a capital gain.

What if you don't have an HP 12C? You can do the same thing in Microsoft Excel. Below is what you'd type into the appropriate cells

Cell A1: -10,000
Cell A2: -1,000
Cell A3: 500
Cell A4: -1000
Cell A5: 12,000
Cell A6: =IRR(A1:A5)
Cell A7:=((((A6/100)+1)^4))-1*100

And you get the same answer in cell A7 that you got when using the HP 12C if you format the cells for "number" to four decimal places. Otherwise, Excel will round things off.

If all this seems like too much work, don't give up. Not knowing your portfolio return is like driving on the freeway blindfolded. Another option is to buy a software program that does the calculations for you.

One piece of software I've used that does this quite well is the BetterInvesting Portfolio Manager. This software program allows you to do enter each transaction into a checkbook-like register and it calculates your return with great precision. It's not cheap, but you can learn about the software and download a free trial here.

Matt Krantz is a financial markets reporter at USA TODAY. He answers a different reader question every weekday in his Ask Matt column at To submit a question, e-mail Matt

Posted 2/27/2006 12:01 AM ET

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