What is the 'Compound Return'

The compound return is the rate of return, usually expressed as a percentage, that represents the cumulative effect that a series of gains or losses have on an original amount of capital over a period of time. Compound returns are usually expressed in annual terms, meaning that the percentage number that is reported represents the annualized rate at which capital has compounded over time.

When expressed in annual terms, a compound return can be referred to as a Compound Annual Growth Rate (CAGR).

BREAKING DOWN 'Compound Return'

The compound return is the rate of return on your investment taking into consideration the compounding effect of the investment for each year. In other words, the compound return can be thought of as the growth rate that gets you from the initial investment value to the ending investment value if you assume that the investment has been compounding over the time period.

For example, if an investment fund claims to have produced a 10% annual compound return over the past 5 years, this means that at the end of its fifth year, the fund's capital has grown to a size equal to what it would be if the funds on hand at the beginning of each year had earned exactly 10% by the end of each year.

For example, suppose you started with an initial investment of $1,000. If you multiply 1,000 by 1.1 five times, that is, $1,000 x (1.1)5, you will end up with about $1,611. If an investment of $1,000 ended up being worth $1,611 by the end of 5 years, the investment could be said to have generated a 10% annual compound return over that 5-year period.

However, this does not mean that the investment actually appreciated by 10% during each of the 5 years. Any pattern of growth that led to a final value of $1,611 after 5 years would equate to a 10% annualized return. Suppose the investment earned nothing for the first 4 years, and then earned $611 in its last year (a 61.1% return for the year). This would still equate to a 10% annual compound return over the 5-year measurement period, since the final amount is still equal to what the $1,000 would have grown to if it had appreciated by a steady 10% each year.

Compound return is viewed as a much more accurate measure of performance of an investment's return over time than the average return. This is because the average annual return does not take compounding into effect, which results in a gross misstatement of an investor's actual returns. For example, if the investment described in the example above earned nothing in the first four years, but earned 61.1% in its fifth year, the average return will be calculated as: (0% + 0% + 0% + 0% + 61.1%) / 5 = 12.22%. Clearly, the average return will overestimate the growth of this investment.

  1. Compounding

    Compounding is the process in which an asset's earnings, from ...
  2. Effective Annual Interest Rate

    Effective Annual Interest Rate is an investment's annual rate ...
  3. Compound

    The ability of an asset to generate earnings, which are then ...
  4. Stated Annual Interest Rate

    The return on an investment that is expressed as a per-year percentage, ...
  5. Annualized Total Return

    Annualized total return gives the yearly return of a fund calculated ...
  6. Cumulative Interest

    Cumulative interest is the sum of all interest payments made ...
Related Articles
  1. Investing

    Continuous Compound Interest

    Different frequency in compound interest results in different returns. Check out how continuous compounding accelerates your return.
  2. Investing

    Overcoming Compounding's Dark Side

    Understanding how money is made and lost over time can help you improve your returns.
  3. Investing

    The Effective Annual Interest Rate

    The effective annual interest rate is a way of restating the annual interest rate so that it takes into account the effects of compounding.
  4. Investing

    How to Make the Time Value of Money Work for You

    How to make the time value of money and power of compounding work for you. Here's a hint: Start saving now.
  5. Investing

    Investing $100 a Month in Stocks for 30 Years

    Find out how you could potentially earn hundreds of thousands of dollars just by investing $100 a month in stocks during your working years.
  6. Investing

    Investing $100 a Month in Stocks for 20 Years

    Learn how a monthly investment of just $100 can help build a future nest egg using properly diversified stocks or stock mutual funds.
  7. Investing

    4 Ways Simple Interest Is Used In Real Life

    Simple interest works in your favor when you're a borrower, but against you when you're an investor.
  8. Financial Advisor

    The Awesome Power of Compounding

    The power of compounding. It may not be sexy, but it is the surest way to accumulate wealth over time.
  9. Investing

    Compounding: My Favorite Term

    Vanguard CEO Bill McNabb shares why "compounding" is his favorite financial term.
  1. What formula calculates interest on interest?

    Find out more about compounding interest, what it measures, and how to calculate the amount of compound interest accrued ... Read Answer >>
  2. How to calculate compound loan interest in Excel?

    Find out about compound interest and how to use the compounding interest formula in Microsoft Excel to calculate the compound ... Read Answer >>
  3. How do I use the rule of 72 to calculate continuous compounding?

    Find out why the rule of 72 does not accurately reflect the growth caused by continuous compounding, and which number can ... Read Answer >>
  4. What is the difference between continuous compounding and discrete compounding?

    Learn to differentiate between and calculate the continuous and discrete compounding formulas for interest-generating investments ... Read Answer >>
Hot Definitions
  1. Liquidity

    Liquidity is the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's ...
  2. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve ...
  3. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  4. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  5. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center