Understanding Annual Return: Definition and How to Calculate it

Understanding Annual Return

An annual return signifies the return on an investment over time, expressed as a time-weighted annual percentage. It encompasses sources like dividends, returns of capital, and capital appreciation. The rate of annual return is compared to the initial investment amount and denotes a geometric mean rather than a simple arithmetic mean.

Key Takeaways

• An annual return, also known as annualized return, indicates the average annual increase of an investment during a specific period.
• The annualized return, calculated as a geometric average, illustrates the compounded annual return.
• An annual return offers valuable insights when gauging long-term investment performance or comparing different investments.
• Various assets, including stocks, bonds, mutual funds, ETFs, commodities, and select derivatives, can have annual returns calculated.

Understanding Annual Return

Annual return computations apply to a range of assets such as stocks, bonds, funds, commodities, and specific derivatives. Comparing investment performances with liquidity is commonly done through this approach, deemed more precise than a simple return due to compounding interest adjustments. Different asset classes exhibit varying annual returns.

Annual Returns on Stocks

Annual returns on stocks, alternatively termed annualized return, convey a stock’s value increase over a specified period. The calculation necessitates information on the current stock price and the purchase price, factoring in any splits. Initial computation involves determining the simple return percentage based on price data, which is then annualed.

The simple return formula: Current Price – Purchase Price / Purchase Price

Example of the Annual Return Calculation

CAGR = ( ( Ending Value Beginning Value  ) 1 Years ) − 1 where: CAGR = compound annual growth rate Years = holding period, in years \begin{aligned} &\text{CAGR} = \left ( \left ( \frac{ \text{Ending Value} }{ \text{Beginning Value } } \right ) ^ \frac{ 1 }{ \text{Years} } \right ) – 1 \\ &\textbf{where:} \\ &\text{CAGR} = \text{compound annual growth rate} \\ &\text{Years} = \text{holding period, in years} \\ \end{aligned} ​((Beginning Value Ending Value​)Years1​)−1where:CAGR=compound annual growth rateYears=holding period, in years​

Imagine an investor buys a stock for $20 on Jan. 1, 2024, then sells it for $35 on Jan. 1, 2029, making a $15 profit and receiving $2 in dividends over five years. The total return of $17 equates to 85% of the initial investment.

The compound annual growth rate (CAGR) formula for 85% over five years:

( ( 37 20 ) 1 5 ) − 1 = 13.1 %  annual return \begin{aligned} &\left ( \left ( \frac { 37 }{ 20 } \right ) ^ \frac{ 1 }{ 5 } \right ) – 1 = 13.1\% \text{ annual return} \\ \end{aligned} ​((2037​)51​)−1=13.1% annual return​

Annualized return differs from standard averages by depicting actual gains or losses and illustrating the effort to recover losses. For instance, losing 50% requires a 100% gain the next year to break even. These returns aid in balancing investment outcomes for better comparison, especially with substantial gains or losses.

Annual return data often feature in marketing materials for mutual funds, ETFs, and individual securities.

Annual Returns on a 401(k)

Determining the annual return of a 401(k) for a specific year involves a distinct calculation procedure. The total return calculation starts with the beginning and final values for the period under review. Contributions during that period are deducted from the end value before computation.

Divide the adjusted final value by the starting balance after adjustments. Subtract 1 from the outcome, then multiply by 100 to determine the total return percentage.

What Is the Modified Dietz Formula?

The Modified Dietz formula considers your cash flow when calculating annual returns, compounding returns across periods.

Are There Other Ways to Calculate Annual Return?

You can compute your rate of return per month and then scale it up by 12 for the annual rate. Numerous online calculators can assist in this process.

How Can I Calculate My Overall Return on an Investment?

Calculate your Return on Investment (ROI) by deducting the initial investment cost from the final value, and dividing by the total investment amount including fees for a percentage return.

The Bottom Line

Analyzing annual return provides insight into your earnings or losses on a specific investment year by year, crucial when seeking growth in stocks, bonds, or mutual funds, and comparing performance with liquidity.

Consult with professionals if you’re uncertain about your calculations to strategize your next investments.