Annual Return
Candlefocus EditorAnnual return, also known as annualized return, is a measure of how much an investment has returned on average over a period of time. This return is usually calculated as the geometric average to reflect what the rate of return would have been on a yearly basis if the returns had been compounded. Annual return is valuable to investors who want to track the performance of investments over time, and to compare the performance of various assets, such as stocks, bonds, mutual funds, ETFs, commodities, and derivatives.
How to Calculate Annual Return
Calculating an annual return is generally straightforward and involves taking a simple return over a period of time and converting it into an annualized rate, by taking a geometric average. To calculate the annual return, you can use the following formula:
Annual return = ((1 + simple return in period 1) x (1 + simple return in period 2) x … x (1 + simple return in period n))^(1/n) -1
For example, if an investor purchased a stock for $100 and it is now worth $120, the investor’s simple return over the period would be 20%. The annual return can be calculated by taking the geometric average of the simple returns over multiple periods (in this case, 12):
((1 + 0.2) x (1 + 0.2) x … x (1 + 0.2))^(1/12) -1
= 1.0215 – 1
= 0.0215 or 2.15%
This shows that, over the course of a year, the asset has returned an average of 2.15%.
Limitations of Annual Return
Although the annual return is a useful measure of performance, it is important to remember that it can sometimes be misleading. This is especially true for investments that experience periods of rapid growth and then slow or negative growth. For these investments, the annual return may hide the underlying volatility of the investment. This is why investors should always consider an investment’s full performance history before making a decision to purchase. Additionally, investors should always be aware of the inherent risks when investing in any asset class.