What Is an Annual Return?
The annual return is the return that an investment provides over a period of time, expressed as a time-weighted annual percentage. Sources of returns can include dividends, returns of capital and capital appreciation. The rate of annual return is measured against the initial amount of the investment and represents a geometric mean rather than a simple arithmetic mean.
Understanding Annual Return
The de facto method for comparing the performance of investments with liquidity, an annual return can be calculated for various assets, which include stocks, bonds, funds, commodities and some types of derivatives. This process is a preferred method, considered to be more accurate than a simple return, as it includes adjustments for compounding interest. Different asset classes are considered to have different strata of annual returns.
- An annual or annualized return is a measure of how much an investment has increased on average each year, during a specific time period.
- The annualized return is calculated as a geometric average to show what the annual return compounded would look like.
- An annual return can be more useful than a simple return when you want to see how an investment has performed over time, or to compare two investments.
- An annual return can be determined for a variety of assets, including stocks, bonds, mutual funds, ETFs, commodities, and certain derivatives.
Annual Returns on Stocks
Also known as an annualized return, the annual return expresses the stock’s increase in value over a designated period of time. In order to calculate an annual return, information regarding the current price of the stock and the price at which it was purchased are required. If any splits have occurred, the purchase price needs to be adjusted accordingly. Once the prices are determined, the simple return percentage is calculated first, with that figure ultimately being annualized. The simple return is just the current price minus the purchase price, divided by the purchase price.
Example Annual Return Calculation
Consider an investor that purchases a stock on Jan. 1, 2000, for $20. The investor then sells it on Jan. 1, 2005, for $35 – a $15 profit. The investor also receives a total of $2 in dividends over the five-year holding period. In this example, the investor's total return over five years is $17, or (17/20) 85% of the initial investment. The annual return required to achieve 85% over five years follows the formula for the compound annual growth rate (CAGR):
(37/20) ^(1/5 (yr)) – 1 = 13.1% annual return
The annualized return varies from the typical average and shows the real gain or loss on an investment, as well as the difficulty in recouping losses. For instance, losing 50% on an initial investment requires a 100% gain the next year in order to make up the difference. Because of the sizable difference in gains and losses that can occur, annualized returns help even out investment results for better comparison.
Annual-return statistics are commonly quoted in promotional materials for mutual funds, ETFs and other individual securities.
Annual Returns on a 401K
The calculation differs when determining the annual return of a 401K during a specified year. First, the total return must be calculated. The starting value for the time period being examined is needed, along with the final value. Before performing the calculations, any contributions to the account during the time period in question must be subtracted from the final value.
Once the adjusted final value is determined, it is divided by the starting balance. Finally, subtract 1 from the result and multiply that amount by 100 to determine the percentage total return.