What is 'Annualize'

To annualize is to convert a rate of any length into a rate that reflects the rate on an annual, or yearly, basis. This is most often done on rates of less than one year, and it usually does not take into account the effects of compounding. The annualized rate is not a guarantee but only an estimate, and its accuracy depends on the variance of the rate.

BREAKING DOWN 'Annualize'

The annualized rate is also known as an "annualized return" and is similar to "run rate". In the case of loan products, the annualized cost is often expressed as an annual percentage rate (APR). The APR considers every cost associated with the loan, such as interest and origination fees, and converts the total of these costs to an annual rate that is a percentage of the amount borrowed.

Annualization Example

Consider a security that returns 1% a month. Because a year consists of 12 months, the security returns 12% on an annualized basis. When dealing with a security that has variable returns, such as a stock, the annualized return cannot always be implied from considering the return over a shorter period. That a security returns 1% in a month is no guarantee that it continues to perform at this level for an entire year; its annualized return could be lower than 12%, or it could be higher.

Annualization is also effective for determining whether a borrower is getting a good deal on a loan. Certain loan products, such as payday loans and title loans, for example, charge a flat finance fee of $15 or $20 to borrow a small sum, such as $100, for a month or less. The fee does not sound like much money, but annualizing it brings to light how expensive it really is. An interest charge of $20 on a one-month loan of $100, annualized, is 240% interest.

Annualizing for Tax Purposes

Annualization can involve converting a taxation period of less than one year to an annual (yearly) basis. This helps income earners to set out an effective tax plan and manage any tax implications.

For example if after the first three months of the year a person earns $10,000, he simply multiplies the $10,000 by four to achieve $40,000, his annualized income. Comparing this level of income to tax charts determines the earner's effective tax rate for the year, which is helpful when budgeting how much income to set aside each quarter for taxes.

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