Investment Performance Avg Annual Return

BenF

Hi,

If I run the subject report configured to show all my investment accounts for all history with no subtotals and compare that to published annual returns for various indexes (S&P500, total stock market, etc) over a similar period, is that a valid comparison, or what are the caveats?

For example, if I run this report for my entire investing life (about the last 20 years) it currently shows an avg annual return of 5.77%. If I compare that to published numbers for fairly aggressive diversified domestic + international portfolios (80% stock/20% bond) which is roughly where I was at over this period, the returns published are roughly 7.25% annualized.

Of course, I did not invest one single lump sum 20 years ago. There is all sorts of buys, sells and dollar cost averaging over the years as I earned money and was able to invest it.

I guess one thing I am struggling with is how the return vs absolute dollar amount of early investments is factored in compared to later investments?

For example, if my balance (realized and unrealized gains) went from $100K to $150K (up $50K) in the early years, say 2000-2003, that is a lot different percentage wise than it going from $1,500K to $1,550K (also up $50K) in more recent years. Also (but perhaps less importantly) that adjusted for inflation $50K was worth more in 2003 than today.

Tom Young

"I guess one thing I am struggling with is how the return vs absolute dollar amount of early investments is factored in compared to later investments?

For example, if my balance (realized and unrealized gains) went from $100K to $150K (up $50K) in the early years, say 2000-2003, that is a lot different percentage wise than it going from $1,500K to $1,550K (also up $50K) in more recent years. Also (but perhaps less importantly) that adjusted for inflation $50K was worth more in 2003 than today. "

The Internal Rate of Return calculation focuses entirely on CASH FLOWS into and out of the portfolio from the start of the investing activity to the end date selected, and the value of the portfolio at the end date.  So all those intermediate realized and unrealized gains are entirely irrelevant to the final calculation.  That might be counter-intuitive, but that's how the math works.

So the important elements to the result are the timing and amount of cash flows, and then the ending value of the portfolio.  A simple example: You invest $100,000 at year 0 and 10 years later the portfolio is worth $200,000.  That works out to an IRR of about 7.17%.  Or you invest $100,000 at year 0 and 1 year later the portfolio is worth $200.000.  That works out to an IRR of about 100%.  Same cash flows, same ending balances, but different results and any activity INSIDE the portfolio is entirely irrelevant.

Jim_Harman

Several points on your questions:

-- Quicken's "Avg Annual Return" is an Internal Rate of Return or IRR calculation. You could Google that for a detailed explanation, but it is equivalent to the interest rate a savings account would have to have earned to produce the same ending balance with the same deposits and withdrawals over the same time period. It is equivalent to Excel's XIRR function.

-- The calculation is annualized, i.e. extended to a full year, so the results may not be useful for analysis or holding periods of less that one year. For shorter periods, it assumes that the performance will continue at the same rate for a full year, which is not  a good assumption for many investments. For short periods, the ROI (%) numbers are generally more useful.

-- This calculation takes into account that for a given IRR, money invested early has longer to compound and thus will produce a higher ending balance.

-- When comparing to published indices, be sure you are using the "Total Return" version of the index, which includes reinvested dividends. Despite what it says in the help text, Quicken's S&P 500 index numbers do NOT include dividends.

-- The calculations are in nominal dollars, not inflation adjusted.

Tom Young

"I guess one thing I am struggling with is how the return vs absolute dollar amount of early investments is factored in compared to later investments?

For example, if my balance (realized and unrealized gains) went from $100K to $150K (up $50K) in the early years, say 2000-2003, that is a lot different percentage wise than it going from $1,500K to $1,550K (also up $50K) in more recent years. Also (but perhaps less importantly) that adjusted for inflation $50K was worth more in 2003 than today. "

The Internal Rate of Return calculation focuses entirely on CASH FLOWS into and out of the portfolio from the start of the investing activity to the end date selected, and the value of the portfolio at the end date.  So all those intermediate realized and unrealized gains are entirely irrelevant to the final calculation.  That might be counter-intuitive, but that's how the math works.

So the important elements to the result are the timing and amount of cash flows, and then the ending value of the portfolio.  A simple example: You invest $100,000 at year 0 and 10 years later the portfolio is worth $200,000.  That works out to an IRR of about 7.17%.  Or you invest $100,000 at year 0 and 1 year later the portfolio is worth $200.000.  That works out to an IRR of about 100%.  Same cash flows, same ending balances, but different results and any activity INSIDE the portfolio is entirely irrelevant.

Bob_L

@Tom Young  I assume that when you say “any activity INSIDE the portfolio, you mean reinvestments, I.e. cash outs along the way will affect the IRR.

Jim_Harman

Activity INSIDE a portfolio can include Buys and Sells as long as the cash remains in the portfolio. These transactions will not show up in the Investment Performance Report but they will affect the IRR because the performance of the securities affects the final balance.

Tom Young

@Bob_L

"I assume that when you say “any activity INSIDE the portfolio, you mean reinvestments, I.e. cash outs along the way will affect the IRR."

Correct.  Cash flows INTO and OUT OF the portfolio are integral to the calculation.  A dividend reinvestment is not, except in the indirect way of affecting the ending balance of the portfolio. 

If you ran an IRR report in the morning, then sold the portfolio for that exact same amount and left the cash in the Account, the IRR report run after the sale would report the same IRR.