Annualised rate of return

Annualised rate of return

Investors frequently want to know how much money they make on their investments. Therefore, the rate of return is the amount they gain on their investments over time. 

Further, investors need to know the annualised rate of return for a few reasons. For one, it allows them to compare different investments. Additionally, an annualised rate of return can give investors an idea of how much their investment will grow over time. 

What is an annualised rate of return? 

An annualised rate of return is a percentage rate that represents the amount of return on investment over one year. It is calculated by dividing the total return by the number of years the investment is held. The annualised rate of return is a helpful tool for comparing different investments. It is also an excellent way to measure the risk of an investment.

How does the annualised rate of return work?

An annualised rate of return is a calculation of how much an investment has earned over a period, expressed as a percentage of the investment’s original value. To calculate it, you take the investment’s current value, subtract the initial value, and divide that number by the actual value. Then, you multiply that number by 100 to get the percentage. 

For example, you invested $1,000 in a stock five years ago. And today, the stock is worth $1,500. To calculate the annualised rate of return, you subtract $1,000 from $1,500 to get $500. Then, you divide $500 by $1,000 to get 0.5. Finally, you multiply 0.5 by 100 to get 50%, which would be the annualised rate of return. 

Keep in mind that the annualised rate of return is not the same as the compound annual growth rate (CAGR). The CAGR is a more sophisticated way of calculating returns that considers the effects of compounding or reinvesting earnings. 

When to use annualised rate of return

There are many circumstances when it might be appropriate to use an annualised rate of return. For example, if you compare the performance of various investments over time, annualizing the return will give you a more accurate picture of which investment is performing better. 

Similarly, annualizing the return will offer you a clearer view of the sort of return you may anticipate earning on your investment if you attempt to determine whether to invest in a specific company or other assets. 

In general, annualizing the return is an excellent way to get a more accurate view of an investment’s performance and can help make investment decisions. 

Formula to calculate the annualised returns

The formula to calculate the annualised return is simple: 

• You need to calculate the total return for the investment period. This is done by taking the investment’s end value and subtracting the start value. 
• You need to divide the total return by the start value. 
• Lastly, multiply the result by 100 to get the annualised return percentage. 

Examples of annualised rate of return

Assuming you have a $1,000 investment, the following table shows how the annualised rate of returns would be calculated for various scenarios: 

Scenario 1: After 1 year, your investment is worth $1,100 

Annualised return = (1100 – 1000) / 1000 = 10% 

Scenario 2: After 2 years, your investment is worth $1,210 

Annualised return = ((1210 – 1000) / 1000) / 2 = 5% 

Scenario 3: After 3 years, your investment is worth $1,331 

Annualised return = ((1331 – 1000) / 1000) / 3 = 3.67% 

As you can see, the annualised rate of return is simply the average return over the investment period multiplied by the number of years. 

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