Annual Return (2024)

The return on an investment generated over a year and calculated as a percentage of the initial amount of investment

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Written byCFI Team

What is Annual Return?

The annual return is the return on an investment generated over a year and calculated as a percentage of the initial amount of investment. If the return is positive (negative), it is considered a gain (loss) on the initial investment. The rate of return will vary depending on the level of risk involved.

Summary

The annual return is a measure of how much the investment has grown or shrunk in one year.
The annualized return is the geometric average of annual returns of each year over the investment period.
The annualized return is useful when you want to see the performance of an investment over time or to compare two investments with different time periods.

Annual Return Formula

The return earned over any 12-month period for an investment is given by the following formula:

Annual Return Example

Assume that you purchased 200 shares at a price of $10 each. You receive $1 in cash dividends after one year, and the share now trades at $9.50. How can you evaluate the performance of the investment that you made a year ago?

It is reasonable to say that the investment can be deemed profitable if the return is positive. Let’s calculate the annual return. In our example:

1. Initial value of the investment

Initial value of the investment = $10 x 200 = $2,000

2. Final value of the investment

At the end of one year, you will hold cash from dividends and 200 shares trading at $9.50. Hence,

Cash received as dividends = $1 x 200 = $200

Current value of shares = $9.50 x 200 = $1,900

Final value of the investment = $200 + $1,900 = $2,100

3. Annualized rate of return

Annualized Return

In the above example, we calculated the return on the investment over a single period of 12 months. However, in practicality, you invest your money in different assets with different time periods. To compare the returns on such investments with a one-year return, you need to annualize them. The rate of return per year, measured over a period either longer or shorter than a year, is known as the annualized return.

The annualized return incorporates compounding; therefore, it is also known as the Compound Annual Growth Rate (CAGR).

Annualized Return Formula

There are two options for calculating the annualized return depending on the available information.

Option 1: When you are given the annual returns for each year of the investment period, then:

Where:

R₁ – The annual return for year 1, R₂ is the annual return for year 2, and so on
n – The number of years you wish to annualize

For example, assume that you purchased 200 shares at a price of $10 each, and you decided to hold onto the shares for three years. The stock rises 10% in the current year, increases by 14% next year, and falls by 15% in the year after. What is the rate of return during the three years that you’ve owned the shares?

Here, R₁ = 15%, R₂ = 14%, and R₃ = -10%

Therefore, you realized an annual return of 5.67% on your investment.

Option 2: When are given a dollar value of returns instead of an annual rate of returns, then:

Where:

n – The number of years you wish to annualize

For example, assume that you purchased 200 shares at a price of $10 each, and you decided to hold onto the shares for three years. You receive $1 per share in cash dividends per year. After three years, you decide to sell all the shares at $12. What is the rate of return during the three years that you’ve owned the shares?

Note that the dollar value of the investments is given here.

1. Initial value of the investment

Initial value of the investment = $10 x 200 = $2,000

2. Final value of the investment

Cash received as dividends over the three-year period = $1 x 200 x 3 years = $600

Value from selling the shares = $12 x 200 = $2,400

Final value of the investment = $600 + $2,400 = $3,000

3. Annualized rate of return

Therefore, you realized an annualized return of 14.47% on your investment.

Additional Resources

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FAQs

How do you explain the annual rate of return? ›

The annual rate of return is the percentage change in the value of an investment. For example: If you assume you earn a 10% annual rate of return, then you are assuming that the value of your investment will increase by 10% every year.

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What is considered a good annual return? ›

General ROI: A positive ROI is generally considered good, with a normal ROI of 5-7% often seen as a reasonable expectation. However, a strong general ROI is something greater than 10%.

How do you calculate the annual return? ›

The yearly rate of return is calculated by taking the amount of money gained or lost at the end of the year and dividing it by the initial investment at the beginning of the year. This method is also referred to as the annual rate of return or the nominal annual rate.

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Is 7% annual return realistic? ›

A 7% return isn't pulled from thin air; it's historically been the average return of the S&P 500, adjusted for inflation.

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How do you explain rate of return? ›

A Rate of Return (ROR) is the gain or loss of an investment over a certain period of time. In other words, the rate of return is the gain (or loss) compared to the cost of an initial investment, typically expressed in the form of a percentage.

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What is annual return in simple words? ›

The annual return is the return on an investment generated over a year and calculated as a percentage of the initial amount of investment. If the return is positive (negative), it is considered a gain (loss) on the initial investment. The rate of return will vary depending on the level of risk involved.

Learn More ›

How much is a good annual income? ›

A Smart Asset report based on MIT's Living Wage data found that the average salary required to live comfortably in the U.S. is $68,499 after taxes. This is nearly $10,000 higher than what the average salary currently is.

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What is a realistic annual rate of return? ›

The average stock market return is about 10% per year, as measured by the S&P 500 index, but that 10% average rate is reduced by inflation. Investors can expect to lose purchasing power of 2% to 3% every year due to inflation. » Learn about purchasing power with the inflation calculator.

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How much money do I need to invest to make $1000 a month? ›

A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.

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How do you calculate the annual return give an example? ›

Example of calculating annualized return

To calculate the total return rate (which is needed to calculate the annualized return), the investor will perform the following formula: (ending value - beginning value) / beginning value, or (5000 - 2000) / 2000 = 1.5. This gives the investor a total return rate of 1.5.

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What is the total annual return? ›

An annualized total return is the geometric average amount of money an investment earns each year over a given period. The annualized return formula is calculated as a geometric average to show what an investor would earn over some time if the annual return were compounded.

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What is annual return of income? ›

An annual rate of return is the profit or loss on an investment over a one-year period. There are many ways of calculating the annual rate of return. If the rate of return is calculated on a monthly basis, multiplying it by 12 expresses an annual rate of return.

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Do 401k double every 7 years? ›

One of those tools is known as the Rule 72. For example, let's say you have saved $50,000 and your 401(k) holdings historically has a rate of return of 8%. 72 divided by 8 equals 9 years until your investment is estimated to double to $100,000.

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What is the 7% rule in stocks? ›

However, if the stock falls 7% or more below the entry, it triggers the 7% sell rule. It is time to exit the position before it does further damage. That way, investors can still be in the game for future opportunities by preserving capital. The deeper a stock falls, the harder it is to get back to break-even.

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What is a good annual return? ›

A good return on investment is generally considered to be around 7% per year, based on the average historic return of the S&P 500 index, adjusted for inflation. The average return of the U.S. stock market is around 10% per year, adjusted for inflation, dating back to the late 1920s.

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How do you explain annual interest rate? ›

A loan's interest rate is the cost you pay to the lender for borrowing money. The Annual Percentage Rate (APR) is a measure of the interest rate plus the additional fees charged with the loan. Both are expressed as a percentage.

What is the simple definition of accounting rate of return? ›

Accounting Rate of Return (ARR) is the average net income an asset is expected to generate divided by its average capital cost, expressed as an annual percentage. The ARR is a formula used to make capital budgeting decisions.

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What is the meaning of annualized rate of return? ›

The annualized rate of return calculates the rate of return on investments by averaging returns on an annual basis. For investors with diverse portfolios, the annualized rate of return makes it easy to compare the performance of different investments.