By: Montana Timpson
As the 2020 fiscal year draws to a close, annual rates of return hit professional traders’ radars as they seek to distinguish years’ top performers. For investors with diverse portfolios, calculating rates of return can help compare the relative performance of multiple investments, making clear which assets won big in 2020.
Calculating Annualized Rate of Return
An annualized rate of return is the calculation for determining investment returns on an annual basis. The annualized rate, also known as the “yearly rate of return” or “annual percentage rate,” works by calculating the rate of return on investments by averaging the returns into a year-long time frame. The annualized rate of return is not to be confused with the annual performance of an investment, which can vary considerably from year-to-year.
Annualized rate of return is calculated with an exponential formula, which takes compounding interest into account. The formula is written as follows, with “P” representing the principal (initial investment), “G” representing gains or losses, and “n” representing number of years:
Annualized Rate of Return = ((P+G)/P)^(1/n) – 1
An even more precise form of annualized return calculation uses days in place of years. The formula is the same, save for the exponent, and is written as follows:
Annualized Rate of Return = ((P+G)/P)^(365/n) – 1
Though annualized rate of return is just one consideration in the performance of an investment portfolio, its calculation can help shed light on 2020’s returns and future performance in 2021.
For more stock market terminology and trading resources, view our active trading blog.
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