Annualized Total Return

What Is Annualized Total Return?

An annualized total return is the geometric average amount of money earned by an investment every year throughout a given time span. The annualized return formula is calculated as a geometric average to demonstrate what an investor would earn throughout some stretch of time on the off chance that the annual return was compounded.

An annualized total return gives just a snapshot of an investment's performance and doesn't provide investors with any indication of its volatility or price vacillations.

Grasping Annualized Total Return

To comprehend annualized total return, we'll compare the speculative performances of two mutual funds. Below is the annualized rate of return more than a five-year period for the two funds:

• Mutual Fund A Returns: 3%, 7%, 5%, 12% and 1%
• Mutual Fund B Returns: 4%, 6%, 5%, 6%, and 6.7%

Both mutual funds have an annualized rate of return of 5.5%, however Mutual Fund An is significantly more unstable. Its standard deviation is 4.2%, while Mutual Fund B's standard deviation is just 1%. Even while breaking down an investment's annualized return, surveying risk statistics is important.

Annualized Return Formula and Calculation

The formula to work out annualized rate of return needs just two factors: the returns for a given period of time and the time the investment was held. The formula is:
$\begin \text = &\big ( (1 + r_1 ) \times (1 + r_2) \times (1 + r_3) \times \ &\dots \times (1 + r_n) \big ) ^ \frac{1} - 1 \ \end$
For instance, take the annual rates of returns of Mutual Fund An above. An analyst substitutes each of the "r" factors with the fitting return, and "n" with the number of years the investment was held. In this case, five years. The annualized return of Mutual Fund An is calculated as:
$\begin \text &= \big ( (1 + .03) \times (1 + .07) \times (1 + .05) \times \ &\quad \quad (1 + .12) \times (1 + .01) \big ) ^ \frac{1}{5} -1 \ &= 1.309 ^ {0.20} - 1 \ &= 1.0553 - 1 \ &= .0553, \text 5.53$
An annualized return doesn't need to be limited to yearly returns. On the off chance that an investor has a cumulative return for a given period, even assuming it is a specific number of days, an annualized performance figure can be calculated; in any case, the annual return formula must be marginally adjusted to:
$\begin &\text = ( 1 + \text ) ^ \frac {365}{ \text } - 1 \ \end$
For instance, expect a mutual fund was held by an investor for 575 days and earned a cumulative return of 23.74%. The annualized rate of return would be:
$\begin \text &= ( 1 + .2374) ^ \frac{365}{575} - 1 \ &= 1.145 - 1 \ &= .145, \text 14.5$

Difference Between Annualized Return and Average Return

Estimations of simple averages possibly work when numbers are independent of one another. The annualized return is utilized on the grounds that the amount of investment lost or acquired in a given year is related with the amount from different years viable as a result of compounding.

For instance, on the off chance that a mutual fund manager loses half of her client's money, she needs to make a 100% return to break even. Utilizing the more accurate annualized return likewise gives a clearer picture while looking at different mutual funds or the return of stocks that have traded throughout various time spans.

Reporting Annualized Return

As indicated by the Global Investment Performance Standards (GIPS), a set of standardized, all inclusive principles that guide the ethics of performance reporting, any investment that doesn't have a history of something like 365 days can't "tighten up" its performance to be annualized.

Consequently, assuming that a fund has been operating for just six months and earned 5%, it isn't permitted to say its annualized performance is roughly 10% since that is foreseeing future performance as opposed to expressing realities from the past. All in all, ascertaining an annualized rate of return must be founded on historical numbers.

Features

• The annualized return formula showcases what an investor would earn throughout some undefined time frame assuming the annual return was compounded.
• Working out the annualized rate of return needs just two factors: the returns for a given period and the time the investment was held.
• An annualized total return is the geometric average amount of money earned by an investment every year throughout a given time span.

FAQ

What Is the Difference Between an Annualized Total Return and an Average Return?

The key difference between the Annualized Total Return and the Average Return is that the Annualized Total Return captures the effects of compounding, though the Average Return does not.For model, consider the case of an investment that loses half of its value in year 1, however has a 100% return in year 2. Essentially averaging these two rates would provide you with an Average Return of 25% each year. Nonetheless, common sense would let you know that the investor in this scenario has really broken even on their money (losing half its value in year one, then, at that point, recovering that loss in year 2). This reality would be better captured by the Annualized Total Return, which would be 0.00% in this occurrence.

How Is Annualized Total Return Calculated?

The annualized total return is a metric that captures the average annual performance of an investment or portfolio of investments. It is calculated as a geometric average, implying that it captures the effects of compounding over the long haul. The annualized total return is at times alluded to as the Compound Annual Growth Rate (CAGR).

What Is the Difference Between the Annualized Total Return and the Compound Annual Growth Rate (CAGR)

The Annualized Total Return is thoughtfully equivalent to the CAGR, in that the two formulas look to capture the geometric return of an investment after some time. The primary difference between them is that the CAGR is much of the time introduced utilizing just the beginning and ending values, while the Annualized Total Return is normally calculated utilizing the returns from several years. This, notwithstanding, is more a question of convention. In substance, the two measures are something very similar.