# Selected excerpts from the Knowledgebase -10

Selected excerpts from the Knowledgebase -10

I’ve decided to do a daily small excerpt from the Knowledgebase as sort of a thought for the day. In many cases they will have extra thoughts of mine, or small updates. I hope you’ll find them interesting.

Saul

Here’s the tenth:

Calculating Portfolio Returns

I retired in July 1996, so I’ve actually been taking out money to live on for the last 20 years, instead of adding money.

Here’s how to calculate your overall returns without getting them distorted by cash flowing in or out. Say you start the year with \$14,000. You want to equate that with 100% and calculate gains and losses from there. So you ask yourself “What number (factor) would I multiply \$14,000 by to get 100?”

By simple arithmetic we have 14000 x F = 100

And thus F = 100/14000 = .0071428

Sure enough 14,000 x .0071428 = 100

Now say three weeks later you have \$14,740 and you want to see how you are doing, you multiply that number by .0071428 and you get 105.3 (so you are up 5.3%). If you don’t add or subtract money, that factor will work for the whole year.

Now say you add \$2300 of fresh money, but you don’t want that to screw up your estimate of how well you are doing.

You add the \$2300 to the \$14,740 and get \$17,040 which is your new balance that you are investing with. That’s your new starting point. It doesn’t affect how you’ve done up to here. You haven’t suddenly done better because you added money. You can’t still multiply by .0071428 because you’d get 121.7 and it would look as if you were up 21.7%, when you are really only up 5.3%.

So you need to change your factor to make it smaller so it will still reflect just the 5.3% gain you’ve made so far. You figure: “What would I multiply my new balance (\$17,040) by to get 105.3, to reflect my 5.3% gain so far this year?”

F x 17,040 = 105.3

F = 105.3/17,040 = .0061795

And that’s your new factor. If you multiply it by 17,040, sure enough you get 105.3. Now you continue to see how you will do for the rest of the year.

If a little later you are at \$18,000, you multiply 18,000 by .0061795 and you get 111.2, so you know that your investing is now up 11.2% for the year.

Same, if you take money out. You don’t want it to look as if you lost money. You calculate a new factor so you start from the same percentage where you were.

On January 1st of the next year, you write down how you did for the year to keep a record, and start over at 100 for the next year.

Saul

For Knowledgebase for this board,
please go to Post #17774, 17775 and 17776.
We had to post it in three parts this time.

A link to the Knowledgebase is also at the top of the Announcements column
on the right side of every page on this board

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How are dividends treated… new income? Would you make adjustment quarterly or annually if considered new income?

How are dividends treated… new income? Would you make adjustment quarterly or annually if considered new income?

Hi Spears,
Dividends are part of the total return from the stock. They are neither money that I am adding to the account nor money that I am taking out of it. I include all cash in my brokerage account as part of my daily balance, and dividends just add to the cash when they come in. Few of my stocks are dividend stocks so it generally makes little difference.
Saul

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Here’s how to calculate your overall returns without getting them distorted by cash flowing in or out.

Say you start in January with \$1,000.

Now say in mid-December, without making any additional deposits or
withdrawals, you see that you have \$1,300 in your account. So far
you’re up 30% for the year.

Now say that same day in mid-December you add \$10,000 of fresh money

At the end of December your brokerage statement shows a balance of \$10,960.

What’s your rate of return for the year?

Some investors are going to have difficulty understanding how they got a
26% return by investing \$11,000 during the year and ending up with \$10,960.

Although this Knowledgebase method of calculating returns is valuable, it can
quickly get novice investors into trouble. I suggest you add a section that
points this out, and contrasts this time weighted method with the money weighted
method.

Thanks,
Ears

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