Annual Return What is an annual return? An annual return (or annualized return) measures the average percentage growth of an investment per year over a specified period. It reflects total returns—capital appreciation plus distributions such as dividends—and is typically expressed as a compounded (geometric) rate rather than a simple arithmetic average. Key takeaways
* Annualized return shows the compounded yearly rate of growth for an investment over a holding period.
* It is more useful than a simple average when comparing investments or evaluating performance across different time horizons because it accounts for compounding.
* Annualized returns can be calculated for stocks, bonds, mutual funds, ETFs, commodities, retirement accounts, and certain derivatives.
How annual return is calculated Basic simple return:
* Simple return = (Ending value − Beginning value) / Beginning value Explore More Resources
Compound annual growth rate (CAGR), the common annualized measure:
* CAGR = (Ending value / Beginning value)^(1 / Years) − 1 CAGR expresses what constant annual growth rate would produce the observed change over the holding period. Explore More Resources
Example: stock investment An investor buys a stock for $20 and, over five years, receives $2 in total dividends and sells the stock for $35.
* Beginning value = $20
Ending value (including dividends) = $35 + $2 = $37
Holding period = 5 years CAGR = (37 / 20)^(1/5) − 1 ≈ 0.131 → 13.1% per year Explore More Resources
This 13.1% annualized return shows the compounded yearly growth that yields an 85% total gain over five years. Annual return for retirement accounts (e.g., 401(k)) When contributions or withdrawals occur during the measurement period, simple beginning/ending comparisons can be misleading. A basic adjusted-period total return is:
* Adjusted return = (Ending balance − Contributions during period − Starting balance) / Starting balance Explore More Resources
Because timing and size of cash flows affect results, money-weighted or time-weighted methods (or formulas like Modified Dietz) are commonly used to more accurately account for inflows and outflows. Other return measures
* Time-weighted rate of return: Removes the impact of external cash flows to show the portfolio’s performance due to investment decisions. Preferred for comparing manager performance.
* Money-weighted rate of return (internal rate of return): Reflects the investor’s actual experience by incorporating the timing and size of cash flows.
* Modified Dietz: An approximation that weights cash flows by the portion of the period they were invested; useful when exact IRR computation is impractical.
* Monthly-to-annual: You can compute periodic returns (e.g., monthly) and convert to an annual rate by compounding the periodic rate (1 + r_month)^12 − 1.
Calculating overall return or ROI
* Return on investment (ROI) = (Final value − Initial cost − Fees) / Initial cost × 100%
Include commissions, fees, and other costs for an accurate percentage.
Practical notes
* Annualized returns smooth results and make comparisons easier, but they hide year-to-year volatility.
* Negative returns can be annualized using the same formulas, but be cautious interpreting averages when returns fluctuate widely.
* For accounts with frequent cash flows, prefer money-weighted measures or methods that properly account for timing.
Bottom line Annualized return quantifies how an investment performed on average each year, accounting for compounding. Use CAGR for straightforward buy-and-hold comparisons, but choose time-weighted or money-weighted measures (or Modified Dietz) when cash flows or manager performance comparisons matter. When in doubt, consult a financial professional to ensure the method matches your needs. Explore More Resources