Annualized Total Return
What Is Annualized Total Return and What Does It Mean?
The geometric average amount of money earned by an investment each year over a certain time period is called an annualised total return. The annualised return formula is a geometric average that shows what an investment would receive if the annual return was compounded over time.
An annualised total return merely gives investors a snapshot of an investment's performance and does not reveal its volatility or price swings.
TAKEAWAYS IMPORTANT
The geometric average amount of money earned by an investment each year over a certain time period is called an annualised total return.
The annualised return formula calculates how much an investment would receive if the yearly return was compounded over time.
Only two factors are required to calculate the annualised rate of return: the returns for a specific period and the length of time the investment was kept.
Getting to Know Annualized Total Return
We'll analyse the hypothetical performances of two mutual funds to better comprehend annualised total return. The annualised rate of return for the two funds during a five-year period is as follows:
Returns on Mutual Fund A: 3%, 7%, 5%, 12%, and 1%, respectively.
Returns on Mutual Fund B were 4%, 6%, 5%, 6%, and 6.7 percent, respectively.
Both mutual funds have a 5.5 percent annualised rate of return, but Mutual Fund A is significantly more volatile. It has a standard deviation of 4.2 percent, while Mutual Fund B merely has a standard deviation of 1%. It's crucial to look at risk statistics even while looking at an investment's annualised return.
Formula and Calculation for Annualized Returns
Only two factors are required to determine the annualised rate of return: the returns for a specific period of time and the length of time the investment was kept. The formula is as follows:
&big ((1 + r 1) times (1 + r 2) times (1 + r 3) times &dots times (1 + r n) big) frac1n - 1 &big ((1 + r 1) times (1 + r 2) times (1 + r 3) times &dots times (1 + r n) big) frac1n - 1
((1+r 1 )(1+r 2 )(1+r 3 )((1+r 1 )((1+r 2 )(1+r 3 )
n 1 ((1+r r r r r r r r r r r r r r r
Take, for example, Mutual Fund A's annualised rates of return. Each of the "r" variables is replaced with the appropriate return, and "n" is replaced with the number of years the investment was held. Five years in this situation. Mutual Fund A's annualised return is determined as follows:
Annualized Rate of Return
5 1 =((1+.03)(1+.07)(1+.05) (1+.12)(1+.01))
1 =1.309 0.20 1 =1.0553 1 =.0553, or 5.53 percent 1 =1.309 0.20 1 =1.0553 1 =.0553, or 5.53 percent
It is not necessary to limit an annualised return to yearly returns. An annualised performance figure can be produced if an investor has a cumulative return for a certain period, even if it is a specific number of days; nevertheless, the annual return formula must be slightly altered to:
begin aligned &textAnnualized Return = (1 + textCumulative Return) frac 365 textDays Held &textAnnualized Return = (1 + textCumulative Return) frac 365 textDays Held &textAnnualized Return = (1 + textCumulative Return) frac 365 textDays Held &textAnnualized Return = (1 + textCumulative Return) frac 365 textDays Held &textAnnualized Return = (1 + text - 1 aligned at the end
Days Held 365 Annualized Return=(1+Cumulative Return) Annualized Return=(1+Cumulative Return) Annualized Return=(1+Cumulative Return
Assume that an investor kept a mutual fund for 575 days and earned a cumulative return of 23.74 percent. This is the annualised rate of return:
Annualized Rate of Return
575 365 =(1+.2374)
1 =1.1451 =.145, which equals 14.5 percent
What Is the Difference Between Annualized and Average Returns?
Simple averages can only be calculated when the numbers are unrelated to one another. Because of compounding, the amount of investment lost or gained in one year is interdependent with the amount from the other years under consideration, the annualised return is employed.
If a mutual fund manager loses half of her client's money, for example, she must produce a 100 percent profit to break even. When comparing several mutual funds or the return of equities that have traded over different time periods, using the more accurate annualised return provides a clearer picture.
Annualized Return Reporting
Any investment that does not have a track record of at least 365 days cannot "ratchet up" its performance to be annualised, according to the Global Investment Performance Standards (GIPS), a set of regulated, industry-wide guidelines that guide the ethics of performance reporting.
Thus, if a fund has just been running for six months and has earned 5%, it is not permitted to state that its annualised performance is about 10% because this is forecasting future performance rather than providing historical facts. To put it another way, calculating an annualised rate of return requires using previous data.
What is the formula for calculating annualised total return?
The annualised total return is a metric that measures an investment's or a portfolio's average annual performance. It's calculated as a geometric average, which means it accounts for compounding effects over time. The Compound Annual Growth Rate is a term used to describe the annualised total return (CAGR).
What Is the Difference Between an Average Return and an Annualized Total Return?
The Annualized Total Return and the Average Return differ in that the Annualized Total Return includes the impacts of compounding, but the Average Return does not.
Consider the situation of an investment that loses 50% of its value in the first year but returns 100% in the second year. Simply averaging these two percentages yields a year-over-year average return of 25%. Common sense, on the other hand, would tell you that the investor in this circumstance has actually made a profit (losing half its value in year one, then regaining that loss in year 2). The Annualized Total Return, which in this case would be 0.00 percent, would be a better representation of this reality.
What is the difference between the Compound Annual Growth Rate and the Annualized Total Return? (CAGR)
In that both formulas strive to capture the geometric return of an investment over time, the Annualized Total Return is conceptually similar to the CAGR. The key distinction is that the CAGR is frequently given using only the beginning and ending data, but the Annualized Total Return is frequently calculated utilising returns from many years. This, on the other hand, is more a matter of etiquette. In terms of substance, the two measurements are identical.
