What is Annualized Return?
Annualized Return is the geometric mean return of an investment provides over a period of time and expressed in a time-weighted annual percentage. It shows what an investor would earn over a period of time if the annual return was compounded. The Annualized Return is measured against the initial amount of the investment and represents a geometric mean rather than a simple arithmetic mean.
Why used Annualized Return?
Annualized Return, also known as Compound Annual Growth Rate (CAGR), is more accurate than a simple return, as it includes the compounding interest, while simple return just simply add up all the returns without the time-weighted factor. Hence, this makes it one of the best measures when various type of investments are being compared.
How to Calculate Annualized Return?
Client A invested RM100,000 on Unit Trust Fund A with #YourFinanceDoctor on Jan 1, 2007. Assume that Client A would like to sell on Jan 1, 2017 for RM200,000. Client A also receives a total of RM50,000 in dividends over the ten-year holding period. So ending value of investment will be RM250,000 while beginning value of investment will be RM100,000 over 10 years.
Annualized Return = ((250,000/100,000)^(1/10)) - 1 = 9.60%
Simple Return = ((150,000/100,000) x 100%) / 10 = 15%
A Simple Return of 15% a year would seems like a very good investment but in fact the Annualized Return is only 9.60%! (Which is still a good return tho!) Simple Return is commonly used in promotional materials for investments, so beware not to be mislead-ed and always ask for the Annualized Return!