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What Is An Annualized Rate of Return?
The annualized rate of return (ARR) calculates the average yearly return of an investment over a specific period, enabling comparisons across investments and projections of future growth rates.
Oct 16, 2024 at 03:13 pm

- Definition:
An annualized rate of return (ARR) is a measurement used to calculate the average return of an investment or portfolio over a specific period of time, particularly when the investment duration is less than a year. It is often used to compare returns from different investments and to project future growth rates.
- Calculation:
To calculate the ARR, multiply the return by the number of times the return would have occurred in a year. Common periods used are monthly, quarterly, and semi-annually. For example, if an investment yields a 5% monthly return, its ARR would be calculated as 5% x 12 (number of months in a year) = 60%.
- Assumptions:
ARR assumes that the returns are reinvested at the same rate for the entire year, which is not always the case in practice. It also assumes a constant growth rate, which may not be realistic over long holding periods.
- Applications:
ARR is commonly used in the following applications:
Comparing performance of different investments
Forecasting growth rates of stock or mutual fund investments
Estimating potential earnings from bonds or annuities
- Limitations:
ARR has some limitations that should be considered:
It does not reflect the variability of returns over time.
It does not account for inflation or reinvestment risk.
It is only an approximate measure of future returns.
- Example:
Suppose you invest $10,000 in a mutual fund that earns a 4% quarterly return. The ARR for this investment would be:
ARR = 4% x 4 (number of quarters in a year) = 16%
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