New Trustee’s Guide to Investments: Rate of Return

Larry Beebe, CPA

New trustees can be overwhelmed by the investment knowledge that must be quickly acquired to function effectively in their new roles.  This series will provide in-depth information about plan investments to assist new trustees in their fiduciary duty of managing plan assets.

As a new trustee, examining your plan’s investment statements can be confusing.  However, proper examination of plan investments is essential to help you understand the financial position of the plan.  One of the first items to focus on is rate of return.

Rate of return can be defined as the investment income earned by the investments, divided by the average fair market value of investments for the period being measured.  The rate of return is typically expressed on an annual basis.  For example, if a portfolio’s rate of return was 4% over a six-month period, the annualized rate of return would be 8% (i.e. 4% x 2). Your plan’s targeted rate of return should be specified in your plan’s investment policy.

In the case of a pension plan, the plan’s actuary must make certain assumptions in determining whether the plan will have sufficient assets over the long term to pay pension benefits to plan participants and beneficiaries.  The most significant assumption the actuary makes is the plan’s expected rate of return on an annualized basis.  A typical assumed rate of return is in the range of 6.5% to 8% annually.  Ask your actuary to explain to plan trustees how the expected annual rate of return was determined.

Actual rates of return should be calculated on your plan’s total portfolio and by subcategories such as by type of assets and by investment manager.  Rates of return are typically calculated on a monthly, quarterly, annual year-to-date and one, three, five, and ten year periods.

How do you know whether the plan’s investments are performing well?  Rates of return earned are compared to the returns earned by appropriate indices (e.g. Dow Jones Industrial Average, S&P 500 Index).  Custodians or investment consultants can also provide benchmark figures, which should also be compared to the plan’s rate of return in order to determine if your plan’s returns are better or worse compared to others that have a similar approach or strategy.

We recommend that you review this information often.  Your plan’s actuary should review this information with you annually to determine whether your plan is on the right track to meeting its investment objectives.

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