Definition: The annual return measures the profit/loss of investment. Its key construction is the difference between its expected return and its actual return. The actual return can be thought of as the true cash value of an investment; the expected return is simply the difference between that value and the amount spent on it. It is the annual return that investors demand in return for their money invested in an investment, less the cost of capital and taxes. Return is a key factor in investing because it refers to the amount of profit realized over time, not just the capital gains realized over a short period.
An annual return is a measurement of how well an investment is doing for you. Since investment is usually riskier than a simple purchase or cash transaction, an annual return tells you how much you are guaranteed to earn from an investment instead of what could happen if you sell at a higher price or time.
Formula of Annual Return
Annual Return = (Final Value of investment – Initial value of investment) / (Initial Value of investment * 100)
The final value of the investment should include all the interest and dividends during the 12 months.
The annual return can be estimated for short-term investments such as savings accounts and certificates of deposit (CDs) and longer-term investments such as stocks, bonds, mutual funds, and ETFs. In addition, it is sometimes possible to calculate an annual return for an asset without requiring cash flow information, in which case the annual percentage rate (APR) will be determined by adding the annualized rate of return for the five previous years.
Annualized return is a commonly used ratio that expresses the growth potential of a stock compared to the return on equivalent securities of the same type purchased at the beginning of the reporting period. The major advantage of annual returns is that they are resistant to stock market bubbles and can be used as a signal that an investment strategy is generating above-average returns. Since the early 1990s, most stocks have generated annual returns above 20%.
Annual returns provide a detailed look at a company’s performance over time. The information contained within an annual return can give investors a better understanding of how a particular company is performing and how its business operations stack up against other similar companies in the marketplace. An investor can use annual returns in several ways, including getting access to high-quality financial information is one way to increase your investment choices and voice your opinions about companies you’re considering investing in.