Calculating Returns

The Beardstown Ladies’ recent woes have reinforced how important it is for investors to know how their investments are doing. Because the math involved scares some people, let’s run through an example step by step. Imagine Ethel, who begins the year with a portfolio valued at $10,000. At year-end, it’s worth $14,000. Let’s see how it gre (but note: you’d use a slightly different procedure if you lost money).

Divide $14,000 by $10,000, and you get 1.4. Subtract 1, and you have 0.4. Multiply that by 100, tack on a percent sign and voila--you’ve got a 40% increase. It’s that simple. Well, sometimes.

If Ethel added to her investment during the year, as many people do, things get more complicated.

Let’s say Ethel plunked $2,000 of her savings into this portfolio during the year. This means her investments didn’t really appreciate by 40%. The total value of her portfolio did, but partly because of the money she added. Even if the stock prices didn’t budge, her contributions would have resulted in a 20% increase.

If you make intrayear contributions, it becomes more difficult to calculate your actual return. Ideally, you’d use a computer program that can determine the “internal rate of return.” Software such as Intuit’s Quicken (or the Fool’s PortTrak) can do this.

Your trusty calculator can give you an approximate value. Just take the portfolio’s end value and subtract half the net additions made. Divide this by the portfolio’s beginning value plus half the net additions. We’d get: $13,000 ($14,000 minus $1,000) divided by $11,000 ($10,000 plus $1,000) equals 1.18. Subtract one, multiply by 100, tack on that percent sign, and you’re looking at an 18% gain.

Once you know your holdings have appreciated a certain amount, compare that to a benchmark such as Standard & Poor’s 500 stock index. If your portfolio rocketed ahead 25% in 1997, you may have rejoiced. But the market (as measured by the S&P; 500) was up 31% for the year. You underperformed it. Aim to beat the market. But if you can’t beat it, you might want to” join it” by investing in an index fund that matches the S&P; 500.