Your 401k Company is Lying to You

by Kevin on July 27, 2009

Or at least it is most likely lying to you.

I just got my quarterly statement for the second quarter. The first page of information proudly displays my individual rate of return for the quarter. They are claiming I earned 16% in one quarter.

Considering the second quarter was indeed a good one I wasn’t too surprised. Nonetheless I was curious to see if I had really pulled off a 16% return between the beginning and end of the quarter.

Define Individual Rate of Return

What is your definition of individual rate of return?

Mine is pretty simple. It’s the return you get on the money invested. So if you invest $1,000 and at the end of the year your account balance is $1,100… your return is 10%. Pretty basic.

How My 401k Provider Defines Individual Rate of Return

Apparently my 401k company sees things a bit differently. I say this because they included my contributions when calculating the growth of my account.

Let’s go back to my original example. You put $1,000 into your account at the beginning of the year. In the middle of the year you add $50 to the account. At the end of the year the account balance is $1,100. Your rate of return is 10%.

Wait a second.

No, it’s not.

Your rate of return is the difference between your ending balance and your total contributions. So ($1,100 – $1,050)/$1,050 = 4.76%.That’s a big difference compared to the reported 10%!

Your 401k Company Has An Agenda

Remember that this firm has incentive to make itself and your account look good. When times are tough they may not put your quarterly results in big font and bold. When times are great they may emphasize your returns a lot.

All of this is designed to get you to keep putting money into the account. They earn money off of your money so the more the merrier. Don’t be fooled with these reports. (Also don’t be discouraged — keep putting money in.) Calculate your own rate of return taking into account your contributions.

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July 27, 2009 at 9:02 am

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dawn July 27, 2009 at 8:16 am

Including contributions when calculating rate of return does not make any sense. Do you think it’s just your fund company that does this or all of them? do you mind mentioning the name of your fund company?

B7 July 27, 2009 at 9:45 am

Great post! It shows that we have to be very careful of the information that we are given. Mutual fund companies (and many other companies) will simply take our money, give us misinformation, and hope that we don’t notice. 99.9% of the people never notice. So it works.

Love your blog!

Finance Nerd July 27, 2009 at 1:53 pm

This is definitely wrong, and should not be legal. I know that my company does not do it that way, and I’m surprised that yours is gutsy enough to try to get away with it.

Jennifer July 27, 2009 at 10:34 pm

great post – if only people took the time to realize that there’s so much trickery involved with stock market investing. we should talk – i’d like to offer you a copy of my colleague’s book on this topic. glad to find your site – came through on my google alerts.

Golfing Girl July 28, 2009 at 7:26 am

That’s terrible! I’m fairly certain that mine is not calculated that way, but I’ll be certain to check it out on my next statement now!

Kevin August 2, 2009 at 1:27 pm

Hey everyone… check out the follow up post. Turns out I ran some numbers wrong.

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