Annual Rate of Return Calculator
How to Calculate Annual Rate of Return
The Annual Rate of Return (often referred to as the Annualized Return or CAGR – Compound Annual Growth Rate) provides a geometric mean return that represents the consistent annual growth rate required for an investment to grow from its beginning balance to its ending balance over a specific time period.
Unlike a simple percentage return, which only looks at the total profit relative to the investment, the annual rate of return accounts for the time factor. This makes it a crucial metric for comparing investments held for different lengths of time.
The Annual Return Formula
To calculate the annual rate of return manually, you can use the following formula:
Where:
- Ending Value: The current value of the investment or the value at the time of sale.
- Beginning Value: The initial amount invested.
- Years: The holding period expressed in years.
Real-World Example
Let's say you invested $10,000 in a mutual fund.
- After 3 years, your investment is worth $14,500.
- Total Return: ($14,500 – $10,000) / $10,000 = 45%.
- Annual Rate of Return: To find the annual compounding rate:
Calculation: (14,500 / 10,000)^(1 / 3) – 1
= (1.45)^(0.3333) – 1
= 1.1318 – 1
= 13.18%
This means your investment grew at an effective rate of 13.18% every year to reach the final amount.
Why It Matters
Using the annual rate of return is superior to simple return when analyzing long-term investments. A 50% total return sounds impressive, but if it took 20 years to achieve, the annual return is only about 2%. Conversely, a 50% return over 2 years represents a stellar 22.47% annual return.