What is the 'Average Annual Return - AAR'

The average annual return (AAR) is a percentage used when reporting the historical return, such as the three-, five- and 10-year average returns of a mutual fund. The average annual return is stated net of a fund's operating expense ratio, which does not include sales charges, if applicable, or portfolio transaction brokerage commissions.

BREAKING DOWN 'Average Annual Return - AAR'

When you are selecting a mutual fund, the average annual return is a helpful guide for measuring a fund's long-term performance. However, investors should also look at a fund's yearly performance to fully appreciate the consistency of its annual total returns. For example, a five-year average annual return of 10% looks attractive; however, if the yearly returns (those that produced the average annual return) were +40%, +30%, -10%, +5% and -15% (50 / 5 = 10%), performance over the past three years warrants examination of the fund’s management and investment strategy.

Components of Mutual Fund AAR

There are three components that contribute to the AAR of an equity mutual fund. Share price appreciation results from unrealized gains or losses in the underlying stocks held in a portfolio. As the share price of a stock moves fluctuates over a year, it proportionately contributes to or detracts from the AAR of the fund that maintains a holding in the issue. The American Funds AMCAP Fund’s 2.74% holding of Oracle Corporation, a stock it has owned since 2003, has contributed to the portfolio’s 10-year AAR of 8.15% through June 23, 2016, as the company’s stock rose from $10.88 on April 1, 2003, to a close of $40.83 on June 23, 2016.

Capital gains distributions paid from a mutual fund result from the generation of income or sale of stocks from which a manager realizes a profit in a growth portfolio. Shareholders can opt to receive the distributions in cash or reinvest them in the fund. Capital gains are the realized portion of AAR. The distribution, which reduces share price by the dollar amount paid out, represents a taxable gain for shareholders. A fund can have a negative AAR and still make taxable distributions. The Wells Fargo Discovery Fund paid a capital gain of $2.59 on Dec. 11, 2015, despite the fund having an AAR of negative 1.48%.

Quarterly dividends paid from company earnings contribute to a mutual fund's AAR and also reduce the value of a portfolio's net asset value. Like capital gains, dividend income received from the portfolio can be reinvested or taken in cash. Large-cap stock funds with positive earnings typically pay dividends to individual and institutional shareholders. These quarterly distributions comprise the dividend yield component of a mutual fund's AAR. The T. Rowe Price Dividend Fund has a trailing 12-month yield of 1.23%, a contributing factor to the fund’s one-year AAR of 5.55% through June 23, 2016.

Difference From Average Annual Rate of Return

Calculating an average annual return is much simpler than the average annual rate of return, which uses a geometric average instead of a regular mean. The formula is: [(1+r1) x (1+r2) x (1+r3) x ... x (1+ri)] (1/n) - 1, where r is the annual rate of return and n is the number of years in the period. The average annual return is sometimes considered less useful for giving a picture of performance of a fund because returns compound rather than combine. Investors must pay attention when looking at funds to compare the same types of returns for each fund.  

RELATED TERMS
  1. Mutual Fund

    Mutual funds combine money from many investors to invest in a ...
  2. NAV Return

    The NAV return is the change in the net asset value of a mutual ...
  3. Distribution

    Distribution occurs when a mutual fund, company or retirement ...
  4. Pooled Funds

    Pooled funds aggregate capital from a number of investors, as ...
  5. No Transaction Fee Mutual Fund

    A no transaction fee mutual fund is a mutual fund with no associated ...
  6. Relative Return

    Relative return is the return an asset achieves over a period ...
Related Articles
  1. Investing

    Comparing Consumer Discretionary Mutual Funds to XLY (VCDAX)

    Discover the top four consumer discretionary funds positioned to rebound on the back of the rise in consumer spending and learn how they could help your portfolio.
  2. Investing

    Fidelity's Mutual Fund Peter Lynch Was Once a Manager (FMAGX)

    Discover the 2016 portfolio trends in the Fidelity Magellan Fund, and learn if they can help your portfolio to maximize profits and minimize losses this year.
  3. Investing

    The 4 Best American Funds for Growth Investors in 2016

    Discover four excellent growth funds from American Funds, one of the country's premier mutual fund families with a history of consistent returns.
  4. Investing

    Trading Mutual Funds for a Living: Is It Possible?

    Find out why trading mutual funds for a living isn't your best bet, including how funds discourage short-term trading and which options may better serve you.
  5. Financial Advisor

    How to Rate Your Mutual Fund Manager

    What to really look for when you're deciding on a mutual fund.
  6. Investing

    When to buy a mutual fund

    Doing a little research can help you find out if mutual funds are a good fit for your portfolio.
  7. Investing

    Consider These Fees When Evaluating Mutual Funds

    The best way to evaluate a mutual fund is by digging a bit deeper into the fees charged.
  8. Financial Advisor

    5 Characteristics of Strong Mutual Fund Shares

    Discover some of the basic characteristics shared by good mutual funds that investors can use to help them in selecting funds.
RELATED FAQS
  1. How often do mutual funds pay capital gains?

    Find out how often mutual funds distribute capital gains income, including the basics of how mutual funds work and why frequent ... Read Answer >>
Hot Definitions
  1. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  2. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  3. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  4. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  5. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
  6. Watchlist

    A watchlist is list of securities being monitored for potential trading or investing opportunities.
Trading Center