If you’re an investor or trader, chances are that you want to see great returns on your investments. One of the most common ways to measure your returns is through the annualized rate of return (ARR) metric. Simply put, this is the percentage returns of your portfolio over a period of time.
In this blog post, we’ll show you how to calculate your own percentage return using two different methods.
The first method is particularly useful to compute returns over many years and uses the following formula:
AP = ((P + G) / P) ^ (1 / n) – 1
P = principal, or initial investment
G = gains or losses
n = number of years
AP = annualized performance rate
For example, assume an investor invested $50,000 into a mutual fund and, four years later, the investment is worth $75,000. This is a $25,000 gain in four years. Thus, the annualized performance is:
ARR = (($50,000 + $25,000) / $50,000) ^ (1/4) – 1
In this example, the annualized performance is 10.67 %.
A $25,000 gain on a $50,000 investment over four years is a 50 percent return. It is inaccurate to say the annualized return is 12.5 percent, or 50 percent divided by four because this does not take into effect compound interest. If reversing the 10.67 percent result to compound over four years, the result is exactly what is expected:
$75,000 = $50,000 x (1 + 10.67%) ^ 4
This method is simpler to use and uses the following formula:
ARR = (Gains / Starting Equity) * 100
For instance, if you started with $10,000 and made $2,000 at year’s end, your return would be 20%.
ARR = (2,000 / 10,000) * 100
By the way, when you open a free account at Trademetria , our system will crunch your numbers and calculate your ARR for you along with 370 other data points.