How Your 401k Is Misleading You

The screenshots above are real world 401k information from a client. He showed it to me asking how the heck average returns are calculated, given that most of his “returns” are actually from his own contributions.

Yet, the 401k provider is showing his annual returns of 8.49% since 2006. I calculate that he should have $567k in this portfolio if he actually did contribute $16k a year with an initial starting value of $96k. In fact, it gets worse as he says he’s been putting the maximum allowed into the plan.

So, how they are calculating returns? I don’t know. And that is always a problem with investment rates of returns.

Let’s say you start year 1 with $100. At the end of year 1, your account has grown to $200. That gives you a 100% return.
But the next year, you lose 50% of your money and thus you’re back down to $100.

What’s your return? Well it could be 50% or 0 depending on how it’s calculated. You get a 50% return by taking your year 1 return of 100% and subtracting your year 2 loss of 50% to give you 50%. But that would be silly as you made 0 dollars. Your actual return is 0.

So, the moral of the story, the ONLY thing that matters is how much your portfolio is worth and how much you put in it. Nothing else matters. Always remember that.

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