Insights from calculating previous 7 Years Annual and Real Return

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SantaClaraSurfer
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Insights from calculating previous 7 Years Annual and Real Return

Post by SantaClaraSurfer »

I ran a rough calculation of all our retirement savings inputs and annual returns over the last seven years and came up with:

Jan 2017-May 2023:

2.17% Annual Return
-2.11% Real Annual Return

Annual Calculation: (Current Value/CostBasis)^(1/6.5)-1
Real Calculation: (Current Value/(RealValueofCostBasis+AnnualAppreciation)<<<AdjustedforInflationbyYear)^(1/6.5)-1

(Edit: for calculation purposes I used 6.5 years, but post still will say seven in the text. The result is very similar.)

It's easy for my wife and I to see this because, aside from a very small 401(k) and pension, we only began retirement savings in earnest in 2017. In our case, our nominal return numbers were hard hit by the 2022 market downturn, since 2021 and early 2022 were by far and away our best years for retirement savings.

I've got a few thoughts on this:

1. Behaviorally we are savers first, and investors second. So this outcome doesn't throw us off that much. (ie. Our goal was to put money away into a diversified portfolio, and we've done that.) Our overall portfolio has grown significantly in the past seven years. Nominally, it's up.

2. Our returns versus "mental expectations" (which I would put as expecting to average out a 5-7% annual return for a 75/25 portfolio) are obviously disappointing. But our real returns of -2.11% annual over seven years are the most significant outcome. Inflation is incredibly impactful on retirement savers, and it hit hardest exactly when both our equities and bond funds nosedived, for a triple whammy.

3. There is no alternative to continuing to save and invest in a diversified portfolio as our number one priority. (Our savings rate is a bit over 30%.) There is no alternative financial product that I know of for this situation, ie. negative real returns, so the only option is to stay the course with our plan and definitely not try to "catch up" or "juice things" somehow. For us, it's good to keep in mind that this outcome for the previous seven years is magnified, mostly because we only caught a small part of the run up between 2011-2021, as we had much less to invest in 2017, 18, 19 and 20.

4. I do have one mindset shift I am taking. Personally, I've noticed that sometimes posters here "don't count" or "don't count on" Social Security in their future planning. However, when I look at our likely Social Security dates (2035 and 2040), add our small pension (not inflation adjusted), and then add our EE and I Bond ladders, I can see that we have a very solid base for the years 2035-2065 so long as we work as planned and keep purchasing our US Savings Bonds.

From a "stay the course" perspective (versus, say, looking at our overall portfolio) I think doing that math is a solid way to gut check our retirement planning in an inflationary environment. Calculating SSI + Pension + US Savings Bonds provides a good baseline, especially as the SSI and I Bond components are inflation adjusted.

Now, there are a metric ton of crutches and truisms that have been dying at the sword of reality lately (expecting 5-7% nominal returns, total bond funds always "protect you" from equity declines, equities always provide a solid line of defense against inflation for accumulators). As a newer retirement saver, this is perhaps a good reality check, if not a bit of a trial by fire. I can now add a truth to that pile of truisms.

Inflation is serious and impacts real returns.

I don't know where things go from here, but I do know our game plan will be to stay the course and continue to save money.
Last edited by SantaClaraSurfer on Wed May 31, 2023 12:37 pm, edited 2 times in total.
Valuethinker
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Re: Calculating previous 7 Years Annual and Real Return

Post by Valuethinker »

It does not look to me like you are taking into account timing of inflows?

The best way to do this is to use an Excel spreadsheet.

One column is dates of contributions
Adjacent column is the values of each inflow
You then make your final value an outflow (ie if you had $250k that would be -250,000).

Then =XIRR(values, dates,0) where values is your range of value cells, dates is your date cells. 0 is the "guess" at the right number ie 0% pa, and it sounds like you will be quite close to 0 -- IRR or XIRR sometimes needs a bit of "help" to guide it to the right answer.

If that's too much data, then you can just use your year end portfolio values (could be quite large inaccuracies depending upon size and timing of contributions) and =IRR(values). The =IRR assumes all the cash flows are at the same date, year by year.

That should give you an IRR. The Internal Rate of Return will be equivalent to your return in this case.
Topic Author
SantaClaraSurfer
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Re: Calculating previous 7 Years Annual and Real Return

Post by SantaClaraSurfer »

Valuethinker wrote: Tue May 30, 2023 11:20 am It does not look to me like you are taking into account timing of inflows?

The best way to do this is to use an Excel spreadsheet.

One column is dates of contributions
Adjacent column is the values of each inflow
You then make your final value an outflow (ie if you had $250k that would be -250,000).

Then =XIRR(values, dates,0) where values is your range of value cells, dates is your date cells. 0 is the "guess" at the right number ie 0% pa, and it sounds like you will be quite close to 0 -- IRR or XIRR sometimes needs a bit of "help" to guide it to the right answer.

If that's too much data, then you can just use your year end portfolio values (could be quite large inaccuracies depending upon size and timing of contributions) and =IRR(values). The =IRR assumes all the cash flows are at the same date, year by year.

That should give you an IRR. The Internal Rate of Return will be equivalent to your return in this case.
I stated that this is an approximate value. I calculated Annual Contribution and Annual Net Appreciation for each AA component providing an EOY Retirement Portfolio Total. This gave me a simple rough calculation for annual return. I then calculated the real 2023 value of each year's Annual Contribution + Annual Net Appreciation for each year, and then totalled those to create a value to calculate the annual real return.

I used Sheets with the formula I indicated.

Cumulative inflation between January 2017 and April 2023 was 24.92%.

It's reasonable to think that an investor with our inflows (mostly in 2020/21/22) would have negative real annual returns looking back in early 2023. I know these numbers (narrowly positive nominal returns) square with what I'm seeing in our accounts.
deikel
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Re: Insights from calculating previous 7 Years Annual and Real Return

Post by deikel »

The CAGR for the S+P500 over the last 6-7 years is more then 7% (inflation adjusted already)

http://www.moneychimp.com/features/market_cagr.htm

In what are you invested to be so far off ?

7 years is just not long enough to make any statement. But yes, inflation sucks for everyone holding assets and money and is a boon for everyone that holds debt...with the largest debtor of them all being the government.
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immediately and destroy any copy or remembrance of it.
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SantaClaraSurfer
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Re: Insights from calculating previous 7 Years Annual and Real Return

Post by SantaClaraSurfer »

deikel wrote: Wed May 31, 2023 3:18 pm The CAGR for the S+P500 over the last 6-7 years is more then 7% (inflation adjusted already)

http://www.moneychimp.com/features/market_cagr.htm

In what are you invested to be so far off ?

7 years is just not long enough to make any statement. But yes, inflation sucks for everyone holding assets and money and is a boon for everyone that holds debt...with the largest debtor of them all being the government.
You're reading it with flat contributions.

However, 58% of our contributions have come after January of 2021, ie. the last 30 months of a 78 month period, and only 8% of our contributions were made in the first 22 months of the period.

Our portfolio is 75/25 equities/bonds, with 47% US Market, 28% Int'l, and 25% Bonds and a .05% overall expense ratio.

Aside from a following a "Vanguard TDF" weighting to Int'l, there's nothing exceptional about our portfolio that's negatively impacting our overall return.

I'm very sure that I've calculated these numbers accurately, although admittedly roughly. I also follow Boglehead principles. I've followed the forum since 2019 and am grateful for the lessons I've learned. It's helped keep my ER low, and to avoid tempting mistakes.

However, it is totally possible to have a negative real return investing over the last 6.5 years.

Inflation impacts everyone. I see it in much more stark relief because I don't have the run up in US equities as a backdrop. I think that's a valuable perspective.

What's much more interesting to me than any mistake I might have made in my calculations or in my portfolio (the only topics that responses to my post have so far explored) is to discuss what these negative real returns mean for retail investors overall. After all, everyone's investments over the last few years are performing roughly the same way. High inflation will always decimate real returns. I just see the impact more starkly.

It's easy to find materials that are written as if a 6-7% annual nominal return for a typical retirement investor is the bog standard. It's safe to guess that the implied annual real return in those projections would then be somewhere around 4-5%. I remember reading these numbers when selecting our TDF funds in our 401(k)s.

However, if my average is around 2% nominal and -2% real for the last seven years, I will need some bumper crop returns over the upcoming 7 years to start seeing "normal numbers" in my averages 7 years from now, which will be 14 years into my Boglehead journey.

Is anyone predicting 12% nominal and 10% real returns well into the extended future? If anything, they are predicting the opposite.

To be clear, I don't think we need those returns. We are doing fine right now saving 30% per year into a diversified portfolio.

In fact, I can say, without a doubt, that it is completely possible, as a saver, to grow one's wealth and portfolio in this kind of environment. We simply save more, and we use every tool available to us that allows us to lock guaranteed, or inflation-matched, or tax free returns (like EE Bonds and I Bonds and tax free Muni bonds.)

We are much better off than we were seven years ago, and we are well on our way to a solid retirement someday, even with inflationary headwinds and a recent down market that leaves us far short of 7% nominal annual returns. We are not trying to "catch up."

And I can say this looking the numbers in the eyes.

That's good, because I am pretty sure that it's this mindset that is going to allow us to stay the course.
billaster
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Re: Insights from calculating previous 7 Years Annual and Real Return

Post by billaster »

SantaClaraSurfer wrote: Sat Jun 03, 2023 2:03 pm However, 58% of our contributions have come after January of 2021, ie. the last 30 months of a 78 month period, and only 8% of our contributions were made in the first 22 months of the period.

... I'm very sure that I've calculated these numbers accurately, although admittedly roughly. I also follow Boglehead principles. I've followed the forum since 2019 and am grateful for the lessons I've learned. It's helped keep my ER low, and to avoid tempting mistakes.

... However, it is totally possible to have a negative real return investing over the last 6.5 years.

... What's much more interesting to me than any mistake I might have made in my calculations or in my portfolio (the only topics that responses to my post have so far explored) is to discuss what these negative real returns mean for retail investors overall. After all, everyone's investments over the last few years are performing roughly the same way. High inflation will always decimate real returns. I just see the impact more starkly.
Well, the mistake in your calculations means everything and leads to a false conclusion. You haven't had 7 years of negative real returns. You have had one year of negative real returns. That isn't unusual in an investing lifetime.

Most of your money was invested in one bad year. It doesn't make sense to average what is primarily a one or two year investment as if it were invested for 7 years. Timing of cash flows is important and why an internal rate of return is calculated using XIRR.
bgf
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Re: Insights from calculating previous 7 Years Annual and Real Return

Post by bgf »

This is a good exercise in money-weighted returns vs. time-weighted.

My money weighted return is only 3.9% going back to Feb 2015. This is poor, but most of my contributions have come in recent years as my income has increased. And that corresponded with pretty high and rising markets until ‘22. We’re also measuring during a bear market, or soon thereafter.

Time-weighted return is higher.

If you are 100% invested in VOO or SPY then referencing the SP500 return is fine. I benchmark vanguards 2050 TDF which includes bonds (slammed) and international (yeesh), so it’s not going to look good next to a pure SP500 return.

Plus you also have 401k costs, HSA fees, etc all reducing your return somewhat.
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Topic Author
SantaClaraSurfer
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Re: Insights from calculating previous 7 Years Annual and Real Return

Post by SantaClaraSurfer »

billaster wrote: Sat Jun 03, 2023 4:23 pm
SantaClaraSurfer wrote: Sat Jun 03, 2023 2:03 pm However, 58% of our contributions have come after January of 2021, ie. the last 30 months of a 78 month period, and only 8% of our contributions were made in the first 22 months of the period.

... I'm very sure that I've calculated these numbers accurately, although admittedly roughly. I also follow Boglehead principles. I've followed the forum since 2019 and am grateful for the lessons I've learned. It's helped keep my ER low, and to avoid tempting mistakes.

... However, it is totally possible to have a negative real return investing over the last 6.5 years.

... What's much more interesting to me than any mistake I might have made in my calculations or in my portfolio (the only topics that responses to my post have so far explored) is to discuss what these negative real returns mean for retail investors overall. After all, everyone's investments over the last few years are performing roughly the same way. High inflation will always decimate real returns. I just see the impact more starkly.
Well, the mistake in your calculations means everything and leads to a false conclusion. You haven't had 7 years of negative real returns. You have had one year of negative real returns. That isn't unusual in an investing lifetime.

Most of your money was invested in one bad year. It doesn't make sense to average what is primarily a one or two year investment as if it were invested for 7 years. Timing of cash flows is important and why an internal rate of return is calculated using XIRR.
When you say, "You haven't had 7 years of negative real returns. You have had one year of negative real returns" and ""Most of your money was invested in one bad year." I'm not sure what you are referring to.

Inflation between May 2021 and May 2023 was 12.69%.

The return on a 50% US / 25% Int'l / 25% US Total Bond in the same time frame was -2.99% CAGR leaving $9,386 on a $10,000 investment, and $8,263 when you click on "inflation adjusted" in Portfolio Visualizer.

Inflation has been high for more than one year. The nominal return on a portfolio like mine in that same time frame has been less than inflation.

I guess my question is, is it not possible to use common sense to engage those numbers? Inflation high. Nominal return negative. That means real return will be worse.

My 401(k) provider displays my overall return today as -7%. I know that's not counting inflation; I also know that if I did factor in inflation during the timeframe they are measuring (since May 2021), regardless of how specifically accurate my calculation was, the result would not be better than -7%!

It's not like I've stuffed my 401(k) with esoteric investments that created an abnormal result. VTSAX is 52% of my 401(k) and my all time number for VTSAX is -1.16%, for VTIAX, which is 26% of my account, that number is -4.29% all time as of today. Obviously, like everyone else, my bond index funds have declined even more than my equities. And, like everyone else, I know that inflation would make those returns much more negative.

When I opened up a spreadsheet last weekend, I calculated that if for every year between 2017 and now, I took my total principal and appreciation at the end of the year and cashed out into a inflation-matched fixed income instrument, I would have about 13% more in those inflation-matched funds than I have in my portfolio now. That's what I based my calculation on. I'm open to being shown how that's not a valid calculation.

But if the conversation is only "your calculating it wrong" or even "it's hard to calculate internal return accurately unless you set up your portfolio tracking spreadsheets to do so from the beginning" then it seems we're not going to be in a good place to have a conversation about how Bogleheads can adapt to inflation and low, or negative, nominal returns, which has clearly impacted everyone's portfolio, not just mine.

That's the discussion I was trying to engage, especially from the perspective of newer retirement investors, like me.

Look, I'm open to being wrong AND being called wrong-headed, but, at core, I don't think I'm making an invalid overall point about inflation or recent returns. For us, we've made most of our investments after January 2021; we wouldn't change anything, but our situation is pretty clear when we look at our accounts. In Sept. of 2022, our holdings of SCHB/SCHF/SCHE/SCHC were all negative, and we'd been buying them since 2019. Our SCHE and SCHC are still negative.

Regarding using XIRR, I'm very open to learning (always helpful if you can provide a link), the ways in which financial planners calculate the real return on investor's portfolios. But when I search youtube videos about XIRR, the examples (small business here, real estate investment here) tend to be about how a small business makes an initial outlay on a single, individual investment and then tracks a profit and loss, not how a retirement investor keeps track of their overall portfolio versus inflation, which is going to have hundreds, if not thousands, of inputs. I would think that there's got to be a better way. Again, always happy to learn more!
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SantaClaraSurfer
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[Corrected w XIRR] Insights from calculating previous 7 Years Annual and Real Return

Post by SantaClaraSurfer »

bgf wrote: Sat Jun 03, 2023 4:56 pm This is a good exercise in money-weighted returns vs. time-weighted.

My money weighted return is only 3.9% going back to Feb 2015. This is poor, but most of my contributions have come in recent years as my income has increased. And that corresponded with pretty high and rising markets until ‘22. We’re also measuring during a bear market, or soon thereafter.

Time-weighted return is higher.
Thanks for highlighting this!

It took me a moment, but I was able to track down two online guides to using XIRR and Excel/Sheets to calculate money-weighted returns for retirement investments. (Not as easy as it might seem.)

The first guide (from the Monevator blog) is very layperson friendly and keeps it simple, while the second guide, from forum participant White Coat Investor's website, offers both a description of measuring dollar-weighted return using XIRR and some robust discussion. (There is also a Boglehead spreadsheet from the wiki that will help you do this while tracking both money-weighted and time-weighted returns, but only if you have been tracking your annual return every year as you go.)

To make these XIRR calculations, I used my complete lot history from Schwab to get the dates and cost basis for every investment I've made in the last 5 years, as well as my current overall market return (needed for the XIRR calculation.) I then used the XIRR function and calculated for each investment individually, and for the portfolio overall. Finally, I calculated versus cumulative inflation by lot to generate the column XIRR real.

(As I've only got the complete data from Schwab easily-accessible, I've left off some of the other components of our retirement portfolio that I included in the previous calculation, including my 401(k) which, due to work timing issues, was heavily-weighted to late 2021 and early 2022.)

Here are my updated numbers for the years 2018-2023 for my core taxable holdings, and some insights I gained:

Code: Select all

	% Held	XIRR	XIRR real
	
All	100.00%	5.13%	0.49%

SCHB	53.45%	7.98%	3.21%
SCHF	25.78%	5.45%	0.90%
SCHE	14.33%	-4.26%	-8.68%
SCHC	6.45%	-2.12%	-6.31%
First, I stand corrected as the XIRR money-weighted return yields on our Boglehead taxable portfolio overall stand at:

5.13% Annual Return (versus my previous calculation of 2.17%)
0.49% Real Annual Inflation-adjusted Return (versus my previous calculation of -2.11%)

It was hard for me to get my head around the Money-weighted return at first since for a 5.13% annual return the way that I was used to thinking about it had me mentally calculating a 5.13% annual return on the entire sum each year for an entire period (typically this is quoted as return on a $10,000 investment for the previous 5 years in investment materials), but that's not the case with XIRR money-weighted return. Instead, I definitely had a 5.13% annual return, but for each year, that yield is only for the portion of my portfolio that I had invested up to that point. I went back and checked the 5.13% return as my investment inputs progressed year by year, and the math completely checks out! This approach now makes sense to me.

What this tells me is that the nominal return for my Boglehead taxable portfolio performed closer to the typical nominal performance of equities than I had previously calculated it. Our international allocation (SCHF/E/C) also definitely impacted our overall results. Since we had invested 46.5% in International and kept 21% (...which is a bit higher than our IPS due to a one-time adjustment...) of our overall total between Emerging (SCHE) and Small Cap Int'l (SCHC) we've been impacted by the negative performance of those investments. While US equities have generated 7.98% annual for us overall, Emerging and Int'l Small Cap have dragged our overall number down, with -4.26% and -2.12% returns respectively.

Regarding the timing of our contributions to taxable, they were:

Code: Select all

Year Weight
2018	1.43%
2019	14.96%
2020	16.40%
2021	25.90%
2022	37.55%
2023	3.76% (due for a large contribution in July)
I hope this correction helps clarify my nominal money-weighted returns, from 2018 to the present, using XIRR. However, I do think my point about real returns being a sore spot for recent retirement investors is still relevant.

When I made an XIRR calculation using inflation-adjusted numbers for the cost basis, the real overall annual return for my taxable Boglehead portfolio was narrowly positive, at 0.49% per year.

That's a stark result for one's entire, albeit short, investing history. The average real return for the S&P 500, after all, is 6.829%, and typical conservative benchmarks for real annual returns quoted by a variety of investment experts run higher.

Looking at our portfolio overall, we will need many years that outperform our current results to attain something like a 2.5-4.5% real return from our taxable equities overall. We do have a 3.21% real return on our US equity investment, SCHB. So that's a start.

What's interesting to me is that there are some recent investments, from Sept and Oct of 2022 in particular, where the return of all of the lots is quite healthy, as they have strong nominal returns and inflation has slowed somewhat over the previous 9 months; and there are some longer term investments, like all our emerging market lots from 2019, which are carrying a nominal loss four years later, and so generate an even worse impact when calculated against inflation.
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