@Anonymous wrote:
OK, stupid question here -- I obviously don't fully understand 401(k)'s!
I have an orphaned 401(k) from a previous employer. It currently has a balance of $30,000. How do I calculate the value of this $30,000 in 30 years, assuming that I make no changes to anything at all.
Is this still considered compound interest? Nothing is being reinvested, correct? It's simply whatever number of shares I have right now and how their value increases, I thought. This would really just be the relative percentage growth of the stock market, right?
You don't get compound interest in some investments. Compound interest is interest on interest. If you put money in the bank, the interest compounds year over year. Your bank interest rate is usually yearly (APY) while the interest a bank charges you is periodic (APR) and compounded much more often. Your 401k is likely largely invested in equities (e.g. stocks, mutual funds, etc). These equities don't usually get compound interest per se but when calculating expected returns, you do compound the returns.
A stock in company A moves up or down based on the performance of company A (a little more complicated but basically correct). As company A grows over time, your stock gains value. A 5% gain when the stock is worth 100 dollars is 5 dollars. If the stock goes up to 1000 dollars, a 5% gain is now 50 dollars. As the company grows over time, the stock value also increases. As the stock value increases a 5% gain means more in dollars. With that said, many companies will split stocks, issue new stocks, award dividends, and take other such actions. Some of this, especially reinvested dividends, can be viewed as compound interest, but I don't look at it that way.
If you have $30k in a 401k there is really no way to predict what it will be in 30 years. You can make predictions based on underlying assumptions. One common metric used for equity performance is a 7% growth rate year over year. This is because historically the stock market has grown about 7% each year. With that said, some years are worse than others and the last 20 years have been underperforming years. But over time (50+ years) the market usually grows at a rate close to 7%. This 7% growth rate is a compounded rate. If you invested broadly in equities (something like the S&P 500 index) over many years (20-30+), you will likely see positive returns around this rate, but there are no guarantees. Many 401k plans, however, are not purely invested in equities. If you invest in the newly popular target date funds, your portfolio will be weighted towards equities in your 20s and 30s and slowly leverage towards more debt instruments like bonds as you enter your 40s and 50s. Why? Performance of the stock market can be volatile and as you get within 10-20 years of retirement, you should slowly phase in more stable investments.
I have gone a little off-track here, but my point is that you should be careful about making assumptions on the value of your portfolio in 30 years. Also, don't forget to factor in inflation that eats into the buying power of your money (historically about 3.5% in the US each year). Any investment that yields under 3.5% is losing buying power in the long-term.
Short Answer minus all the extras:
1) To calculate your value of your porfolio in 30 years use an investment calculation. One example is here -https://www.edwardjones.com/en_US/resources/calculators/investment_return/index.html
Plug in the expected interest rate to get your answer. Alternatively you can use the following formula: A=P(1+r/n)^nt. A = total money after n years including interest. P = principal amount invested. R= interest rate in decimals. t = number of years (30 for you). n = number of times interest is compounded each year (generally is 1). The compound interest formula is applicable for investments since the principle (compounding) is the same. However, with investments often rate of return and not compound interest is the correct term.
2) Generally investment calculators compound returns. This is similar to compound interest, but one would generally not say a stock has compound interest. However, if you plug in say 7% as your expected returns, the investment calculators will compound them.
