How to Calculate the Expected Rate of Return on a Roth IRA

A Roth IRA is an individual retirement account that lets you invest after-tax dollars. Once you reach age 59 ½ and you’ve held the account for the five-year minimum, your distributions are tax-free. While you’ll typically owe taxes and a 10% fee on early withdrawals, you can withdraw your contributions anytime without penalty.

Because a Roth IRA offers unlimited tax-free growth, you want to maximize your returns. But your gains can vary significantly, depending on the investments you choose. Find out how to calculate the expected rate of return on a Roth IRA.

How Rates of Return Are Determined for Roth IRAs

When you open a Roth IRA, you choose your own investments. Depending on your provider, you may also be able to use a robo-advisor to automatically invest your money, or you could choose a human advisor to actively manage the account.

Your expected rate of return depends on the mix of assets you choose. There are three major asset classes: stocks, bonds, and cash equivalents. Investing primarily in stocks typically yields the highest returns, although it also carries the greatest risk. Investing in cash equivalents like money market funds carries the least amount of risk but typically yields ultra-low returns.

The best way to estimate your Roth IRA returns is to look at the average historical returns for each asset class using market indexes. Although past performance doesn’t guarantee future results, it can give you a sense of realistic returns.

It’s also important to factor investment costs into your Roth IRA returns. Suppose you invest in assets that earn 10% in a year, but your Roth IRA provider charges a 0.5% annual fee. After accounting for the fee, your actual Roth IRA return would be 9.5%.

How to Calculate Your Roth IRA’s Expected Rate of Return

Roth IRA returns aren’t guaranteed, but when you look at historical returns for each asset class and compare that with your asset allocation, you can calculate your expected rate of returns.

Stocks

Stocks are the riskiest of the three major asset classes, but they produce the highest rate of return. One widely used barometer for the performance of domestic stocks is the Standard & Poor’s (S&P) 500 index, which represents more than 80% of the U.S. stock market’s value. Over the past 50 years, the S&P 500 has generated average annual returns just above 10%, assuming dividend reinvestment.

Keep in mind, though, that the stock market’s performance can vary widely from year to year. For example, in 2021, the S&P 500’s return was well over 20%. But in 2008, when the financial crisis took hold, the index lost about 36% of its value.

Bonds

A commonly used benchmark for the bond market is the S&P U.S. Aggregate Bond Index, which tracks the performance of investment-grade debt in the U.S. The index’s average annualized return over the past decade was just 1.6%, as of April 29, 2022.

Compared with stocks, bond returns are significantly less volatile. In 2013, its worst-performing year in the decade from 2012 to 2021, this bond benchmark lost 1.69%. But even in 2019, its best-performing year, the index had a total return of just 8.25%.

Cash

Cash and cash equivalents such as certificates of deposit (CDs) and money market accounts are the most predictable asset class. They’re insured by the Federal Deposit Insurance Corp. (FDIC), so even in the unlikely event that your financial institution fails, you’d get your principal back plus interest on deposits up to at least $250,000.

The average interest rate on a 60-month CD was just 0.32% as of April 2022, the latest data available at time of publication.

Calculating Rates of Return for Hypothetical Roth IRAs

Let’s calculate the rate of return for two hypothetical Roth IRAs over a decade. We’ll assume annual returns of 10% for stocks, 2% for bonds, and 1% for cash, using a compound interest calculator to make projections. For simplicity’s sake, assume you have $100,000 invested and don’t make additional deposits.

85% Stocks, 10% Bonds, 5% Cash

If you’re a relatively aggressive investor, you might allocate 85% of your assets to stocks, 10% in bonds, and 5% in cash equivalents.

Ending value after 10 years: $238,180

40% Stocks, 40% Bonds, 20% Cash

Now let’s say you’re a conservative investor who allocates 40% each to stocks and bonds, with the remaining 20% in cash equivalents. Your Roth IRA money would be safer than the first portfolio if the stock market crashed by 20% or 30%. But your expected returns would be significantly lower.

Ending value after 10 years: $174,600

Keep in mind that average returns aren’t the only thing to consider. Your sequence of returns is important, too. A stock market crash that happens early in your retirement years is often much more devastating than one that happens early in your working years—even if your average annual returns are the same in each scenario. That’s why it’s commonly recommended that you gradually allocate some Roth and traditional IRA money to bonds and cash as retirement nears.

Additional Considerations

There is something else to consider when looking at the return of a Roth IRA or any investment account, and that is no just how much it "earns", but how much of those earnings one gets while it compounds over time and then how much one gets to keep after taxes.

Assuming three different investment accounts, all invested in exactly the same vehicles, you could end up with very different results.

An account that is not a retirement account at all will be funded by money that has already been taxed (so there is less to initially invest), and then be possibly subject to taxes every year (leaving less to compound with annually). Over a long investment horizon, this pool would grow the least.

A traditional IRA is funded with income before it gets taxed (so there is more money available to initially invest), and then it remains untaxed as it grows over time, allowing for tax-deferred compounding. You still have to pay income taxes on your withdrawals when you retire, but that same pool of assets would have grown to be much bigger over a long period of time because the money that annually would have been lost to taxes was instead also put to work every year.

Finally, the Roth IRA's initial contributions were subject to income tax, but gain the benefit of the compounding without being taxed annually. Then, unlike the traditional IRA, the withdrawals made at retirement are not normally taxable, meaning you get to keep more of the earnings when you retire.

These three different accounts, invested identically, would leave the investor with three completely different after-tax returns upon retirement.

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