Kiplinger.com recently added a new calculator tool to its website. In addition to traditional personal finance calculators such as “How Much Do I Need to Save to Retire” and “What Will it Take to Pay Off My Credit Card Balance”, Kiplinger now has a “Recoup your Savings” calculator. The calculator will determine either the amount of time, the annualized rate of return or the amount of annual contributions needed to return to the account's starting value. Simply enter the value of the account before the crash and the current value and then complete two of the three following variables: annual contributions, annual rate of return or time to recoup.
For example, if the account’s starting value was $100,000 and is currently worth $70,000 and the goal is to return to $100,000 in one year without any new contributions, then the calculator computes that the account will need to earn 42.9% annually. If the time period is stretched two years to be back to $100,000 then the annualized rate of return needed is 19.5%.
This calculator is a handy tool for simple scenarios (it does not allow for withdrawals). It also demonstrates two principles that people often overlook in calculating returns for brokerage accounts:
- First, the account dropped from $100,000 to $70,000, a 30% decline (let’s assume over one year). However, to the recoup the losses in one year the remaining diminished account value must to earn 42.5% - quite a bit higher than the drop.
- Secondly, the required annualized ROR drops to 19.5% (not 42.5/2=21.25%) when the time period is extended to two years. This is because of compounding. When people attempt to “annualize” Rates of Return by simply dividing the total ROR by the number of years, the resulting ending value is too high. In this case, the $70,000 would have grown to $102,910 in two years at 21.25% instead of $100,000 at 19.5%.
tags: rate of return, compounding, recouping loss, kiplinger, securities arbitration, securities litigation
