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What Is an Annualized Rate of Return?
Let's consider an investment (such as a stock portfolio) that goes from $1,000 to $1,331 in 3 years. The annualized rate of return (also known as compound annual growth rate or CAGR) is the yearly interest rate that would yield the same increase in value over the same period of time. In this example, it would be 10%, as explained below:
After one year, the investment would be worth $1,000 x 1.10 = $1,100.
At the end of the second year, its value would jump to $1,100 x 1.10 = $1,210.
Finally, after 3 years, it would reach $1,210 x 1.10 = $1,331.
How to Calculate the Annualized Rate of Return?
If we generalize the previous example, we arrive at the following equation:
where F is the final value, I is the initial value, A is the annualized rate of return, and Y is the number of years the investment was held. This equation solves to:
When to Use the Annualized Rate of Return?
Here are some situations where knowing the annualized rate of return can be useful:
Reflecting on your current job, you wonder what has been your average yearly salary % increase since you joined the company, and you would like to compare it to the inflation rate.
Your company stock price has fluctuated a lot over the past five years, and you want to calculate its return (expressed as a percentage) on an annual basis.
You would like to compare the performance of different types of investments you have held for different lengths of time (for example, your savings account versus your investment property).
Tips and Tricks
The time period can be a decimal value. For example, enter 2.5 (years) for 30 months.