Loading the player...

What is an 'Annualized Total Return'

An annualized total return is the geometric average amount of money earned by an investment each year over a given time period. It is calculated as a geometric average to show what an investor would earn over a period of time if the annual return was compounded. An annualized total return provides only a snapshot of an investment's performance and does not give investors any indication of its volatility.

BREAKING DOWN 'Annualized Total Return'

When comparing annualized total return between two funds, take for example the following two hypothetical mutual funds and their annual returns over a five-year period:

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 annualized returns of 5.5%, but Mutual Fund A is much more volatile. Its standard deviation is 4.2%, while Mutual Fund B's standard deviation is only 1%. Even when analyzing an investment's annualized return, it is important to review risk statistics.

Annualized Return Formula and Calculation

The generalized formula to calculate annualized return needs only two variables: the returns for a given period of time and the time the investment was held. The formula is:

For example, take the annual returns of Mutual Fund A above. An analyst substitutes each of the "r" variables with the appropriate return, and "n" with the number of years the investment was held. In this case, five. The annualized return of Mutual Fund A is calculated as:

Annualized Return = ((1 + 3%) x (1 + 7%) x (1 + 5%) x (1 + 12%) x (1 + 1%)) ^ (1 / 5) -1 = 130.9% ^ (0.20) -1 = 105.55% - 1 = 5.53%

Annualized return does not have to be limited to yearly returns. If an investor has a cumulative return for a given period, even if it is a specific number of days, an annualized performance figure can be calculated; however, the formula must be slightly adjusted to:

For example, assume a mutual fund was held by an investor for 575 days and earned a cumulative return of 23.74%. The annualized return would be:

Annualized Return = (1 + 23.74%) ^ (365 / 575) - 1 = 114.5% - 1 = 14.5%

Annualized Return's Difference From Average Return

Calculations of simple averages only work when numbers are independent of each other. The annualized return is used because the amount of investment lost or gained in a given year is interdependent with the amount from the other years under consideration because of compounding. For example, if a mutual fund manager loses half of her client's money, she has to make a 100% return to break even. Using the more accurate annualized return also gives a clearer picture when comparing various mutual funds or the return of stocks that have traded over different time periods. 

Reporting Annualized Return

According to the Global Investment Performance Standards (GIPS), a set of standardized, industry-wide principles that guide the ethics of performance reporting, any investment that does not have a track record of at least 365 days cannot "ratchet up" its performance to be annualized. Thus, if a fund has been operating for only six months and earned 5%, it is not allowed to say its annualized performance is approximately 10%, since that is predicted future performance instead of stating facts from the past.

RELATED TERMS
  1. Annual Return

    Annual return is the compound average rate of return for a stock, ...
  2. Compound Return

    The compound return is the rate of return that represents the ...
  3. Cumulative Return

    Cumulative return involves the total change in price of an investment ...
  4. Total Return

    Total return is a performance measure that reflects the actual ...
  5. Absolute Return

    Absolute return is the percent that an asset rises or declines ...
  6. Abnormal Return

    A term used to describe the returns generated by a given security ...
Related Articles
  1. Investing

    How to calculate your investment return

    How much are your investments actually returning? The method of calculation can make a significant difference in your true rate of return.
  2. Investing

    What You Need to Know About Mutual Funds

    Mutual funds are a good investment opportunity, but investors should know how they operate.
  3. 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.
  4. Investing

    Mutual Fund Due Diligence: 5 Things to Look Out for in Quarterly Reports

    Learn about five important items found in a mutual fund's annual and quarterly reports and why investors should pay attention to changes in these items.
  5. Investing

    4 Mistakes to Avoid When Choosing Mutual Funds to Invest in

    Mutual funds are a great way to build wealth but not all of them are the same. Investors have to be mindful of fees, turnover, redundancy and performance.
  6. Investing

    The Advantages and Disadvantages of Mutual Funds

    As with most investments, mutual funds have both advantages and disadvantages.
  7. Investing

    Analyzing Mutual Funds for Maximum Return

    Using a few simple metrics will help you pick the right fund to provide maximum returns.
  8. 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.
RELATED FAQS
  1. What is a good annual return for a mutual fund?

    Before investing in mutual funds, it's important to understand individual goals for the investment over a specified time ... Read Answer >>
  2. Calculate your portfolio's investment returns

    Learn the basic principles underlying the data and calculations used to perform personal rates of return on investment portfolios. Read Answer >>
Hot Definitions
  1. 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 ...
  2. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  3. 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.
  4. Inventory Turnover

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

    A watchlist is list of securities being monitored for potential trading or investing opportunities.
  6. Hedge Fund

    A hedge fund is an aggressively managed portfolio of investments that uses leveraged, long, short and derivative positions.
Trading Center