Author Topic: How Does Vanguard Calculate Rate of Return?  (Read 11236 times)

ValueIsWhatYouGet

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How Does Vanguard Calculate Rate of Return?
« on: March 04, 2015, 03:47:12 PM »
I'm pretty confused as to rate of return is calculated in my 401k with Vanguard. Logging into my account, it says my 1 year rate of return is 11.4%. However, my portfolio breaks down as follows:

Beginning Balance: $0
Purchases/withdrawals: $57k
Investment Returns: $2.2k

So where does 11.4% come from, because $2.2k on a $57k principal sure smells like 4% to me. Could it be the weighted average performance of the funds I hold rather than my personal return?

I called them today, and after getting transferred to 6 different people over the course of 45 minutes, no one could tell me why.

MDM

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #1 on: March 04, 2015, 04:33:28 PM »
Just guessing: your beginning balance is $0, so you have been with Vanguard <1 year.  Maybe ~4 months?  Annualized, $2.2K/$57K for ~4 months is 11.4% for 1 year.

Indexer

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #2 on: March 04, 2015, 07:08:36 PM »
In investing there are time weighted returns and dollar weighted returns. 

Time weighted returns just look at the investment performance without any consideration for new contributions.  This is how mutual funds normally calculate their returns since money is always going in and out.  The manager is trying to manage what the fund is invested in, he doesn't have a lot of control over the inflows/outflows on a day to day basis so they don't hold that against him or use it in his favor.

For your individual account I believe Vanguard uses Dollar weighted.  Dollar weighted returns figure contributions/withdrawals into returns.  So if you were contributing money and you just happened to dump a ton of money into the market while it was down... like last October... that would cause your returns to be inflated.  So as an example if you had 10k in the 500 index Jan-Dec your returns would match the 500 index most likely or be very close.  However if you added another 100k right when the market was down in October you got to see the whole rebound but your 100k never experienced the pain.  So now you have 10k averaging the index, and 100k experiencing a huge jump and the 100k was only there a few months so its 'annual' return is going to give your total annual return a huge bump.

I hope that helps.  : )

ValueIsWhatYouGet

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #3 on: March 05, 2015, 02:31:39 PM »
Hmm, I'm still a little confused by it. I had contributed pretty evenly last year starting in February and ending in November when I hit the 401k limit. Then I contributed my entire bonus in January 2015 and have maxed out my contribution again for 2015 so I'm still not entirely clear on how that 11.4% # is calculated.

Tester

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #4 on: May 24, 2016, 03:34:23 PM »
I realize this is a very old topic, but I could not find an answer to make me understand what is happening.
If you think this should be closed then close it.

Here is my data:
1 year rate of return
6.6%

1 year activity summary
Beginning balance   $612.41
Net transactions   $27,900.25
Investment return   $765.12
Ending balance   $29,277.78

I really don't understand why does Vanguard show me the 6.6% number.
I could not find a way coming up with that number...
What I can come up from these numbers is 2.7%...
Is this an important thing in finance? If yes, why (I mean, I don't really care of what math they use, in the end I care about how much money I put in and how much money I can get out, not on some cryptic numbers)?

Please help me understand if my expectations are wrong :).

lostamonkey

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #5 on: May 24, 2016, 03:55:14 PM »
I realize this is a very old topic, but I could not find an answer to make me understand what is happening.
If you think this should be closed then close it.

Here is my data:
1 year rate of return
6.6%

1 year activity summary
Beginning balance   $612.41
Net transactions   $27,900.25
Investment return   $765.12
Ending balance   $29,277.78

I really don't understand why does Vanguard show me the 6.6% number.
I could not find a way coming up with that number...
What I can come up from these numbers is 2.7%...
Is this an important thing in finance? If yes, why (I mean, I don't really care of what math they use, in the end I care about how much money I put in and how much money I can get out, not on some cryptic numbers)?

Please help me understand if my expectations are wrong :).

You are doing the math wrong.

765.12/(27,900.25+612.41)=2.7% This formula assumes that the entire 27,900.25 net deposit happened exactly one year from today. The net deposit happened at some point during the year so you would have to use a different formula. It is likely that the 27,900.25 net deposit occurred throughout the year so your actual return would be extremely difficult to calculate.

MDM

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #6 on: May 24, 2016, 04:26:00 PM »
Try copying the table below and pasting into cell A1 of a spreadsheet (you may want to format column A as "dates").  Then google "XIRR" if not familiar with that calculation.

If you know your exact dates and amounts you could adjust accordingly to see if you get the same 6.6%.
27900.25
42125-612.41
42208=-$B$1*C4=1/4
=EDATE(A4,3)=-$B$1*C5=1/4
=EDATE(A5,3)=-$B$1*C6=1/4
=EDATE(A6,3)=-$B$1*C7=1/4
4249129277.78
=XIRR(B3:B8,A3:A8)

Tester

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #7 on: May 24, 2016, 05:22:05 PM »
Thank you for the XIRR part, I will look into that - and I expect to get the same number as Vanguard displays.

I still have a problem with what they are showing, because I don't care at all about some strange numbers, I care about the following things:
Money I contributed/Money I can get out.
What should I do with the 6.6% number when in fact I can only get 2.7% more than what I put in?
They call it 1 year rate of return, but I think they mean that I would get 6.6% if I would leave all there for one year?
So it is a hypothetical rate of return?
It is much easier to verify the numbers in other places because they show the numbers I can understand - one example, I contributed 800USD to Robinhood (80 USD/month) and now I have 912 USD in that account.  They show me the +14% which is the same as the one I can easily compute.
And I can really touch the money which represent that 14% return, while in Vanguard's case I can't touch that money because they are not there.

Please make me understand where/if I am mistaken.
What is the use case for the number Vanguard is displaying?

lostamonkey

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #8 on: May 24, 2016, 05:41:27 PM »
You are confusing total return and annual return. The Robinhood return is total return while the Vanguard number is annual return.
« Last Edit: May 24, 2016, 05:44:10 PM by lostamonkey »

Tester

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #9 on: May 24, 2016, 06:14:35 PM »
You are confusing total return and annual return. The Robinhood return is total return while the Vanguard number is annual return.

I don't think this is the problem, because the numbers in the Vanguard case don't return their percentage.
Why is the annual return different than the total return for a year? What can I do with that information?

They say: at the beginning of the year you had a, you contributed b, your investment return is c and at the end of the year you have d.
And the "1 year rate of return" is x.
Well, x != 100*(c/b)
In my case 100*(c/b) = 2.7 while Vanguard shows me the 1 year return of 6.6%...
I have no doubt they compute that number according to the formula MDM posted above, but I am still having trouble in understanding how to use that number :).
What should that number tell me?
What decision should I take based on that number?



1 year rate of return
6.6%

1 year activity summary
Beginning balance   $612.41
Net transactions   $27,900.25
Investment return   $765.12
Ending balance   $29,277.78

MDM

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #10 on: May 24, 2016, 07:01:11 PM »
They say: at the beginning of the year you had a, you contributed b, your investment return is c and at the end of the year you have d.
And a + b + c = d, so that much is consistent.

Quote
And the "1 year rate of return" is x.
Well, x != 100*(c/b)
x will never = 100*(c/b) unless a=0 and the single contribution date of b was exactly one year ago.

Quote
In my case 100*(c/b) = 2.7 while Vanguard shows me the 1 year return of 6.6%...
What should that number tell me?
What decision should I take based on that number?
In general, you shouldn't make any investment decision based on only one year's return.

Quote
I have no doubt they compute that number according to the formula MDM posted above, but I am still having trouble in understanding how to use that number :).
If we lived in a linear world, you could use that number to project your investment balance one year from now if you make no more contributions or withdrawals.  As we don't live in a linear world (and you shouldn't make any investment decision based on only one year's return) it's not a very useful number.

Let's say your statement was as follows (with some comments):
Quote
1 year activity summary
Beginning balance   $0
Net transactions   $27,900.25 (made yesterday)
Investment return   $765.12 (in one day)
Ending balance   $28,665.37 (today's balance)
Making $765.12 in one day would be an "annual" return of $765.12/$27,900.25 * 365 = 1001%.  Wow! what a big number.  Totally useless (see "not a linear world" above), but hey, it's big!

The timing of your investments has to be considered in the calculations.  Is it making more sense?

Tester

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #11 on: May 24, 2016, 11:24:06 PM »
Yes, thank you. After the first several posts I kind of understood that return is kind of projected for one year if you leave the money there, now you confirmed it.
I don,t take decisions based on one number, but I like to understand what and why I am seeing regarding my money. And I am picky about what I see especially when it does not make sense for a normal person.
I would have liken Vanguard to describe their number in words my grandma (or I 😃) could understand. Their description of that number made absolutely no sense to me 😃. I think I have to learn more about finance, although I would like to see finance companies explain terms in normal language.

Tom Bri

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #12 on: May 24, 2016, 11:42:01 PM »
Tester, I'm with you. I find finance and investing supremely boring, so it is hard to understand what is happening because I fall asleep while reading about it. I have a fair bit invested, but figuring out if they are 'good' investments is hard. Pretty sure they are not 'bad' because I get returns every year. Beyond that? It's a slow process. I finally got around to setting up my Vanguard account today and moved some $ in. Hope it's good. :-)

Heckler

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Re: How Does Vanguard Calculate Rate of Return?
« Reply #13 on: May 25, 2016, 05:19:56 AM »