The average annual return is an important tool investors use to measure and compare the performance of different investments. It’s a useful tool because it provides investors with an easy to understand measure of a fund's past performance over a specific period of time.

Share price appreciation is the increase in the fund unit’s price due to demand and market conditions. Investors can increase their returns by investing in funds at a relatively low price, and then benefit from the share appreciation as the fund exits the market at a higher price. Capital gains, or profits from investments, are the second component of the average annual return. When a fund realizes capital gains from trading investments, these gains are distributed among the fund holders. Dividends, the third component of the average annual return, are usually associated with stocks and bonds. When the fund holds stocks or bonds which pay dividends, these are distributed to investors.

In sum, the average annual return is a critical factor for investors to compare different investments. It measures the return achieved on holdings over a period of time, and indicates how successful a fund was in both generating income distributions, and in increasing in value. Potential investors should review the AAR of a fund before committing to make an investment.