Annualized returns are the annual increase or decrease in the value of an investment, based on information that covers time frames other than a single twelve-month period. Factors such as dividend payments, interest, or unrealized appreciation as it relates to the entire time frame under consideration all have an impact on determining the annualized return as it relates to a specific year. While there is some confusion between what is meant by an annual return and an annualized return, the two terms are not interchangeable, and provide financial data that is very different from one another.
With an annual return, the focus is on a specific twelve-month period, either a calendar year, or twelve consecutive months that may cover portions of two successive years. In contrast, the annualized return requires consideration of multiple periods in order to determine some type of geometric average return that applies to all the periods under consideration. While the former is helpful in assessing returns for one calendar year, the latter provides useful data as it relates to the investment’s performance over more than a single period.
The annualized return is expressed as a percentage, with that percentage either representing an average increase or decrease in the value of an investment over the multiple time periods under consideration. For example, if during a two-year period the return on investment (ROI) comes to twelve percent, then the annualized return would be six percent. This basic annualized return formula can also be used to figure the annualized return as it relates to shorter time frames. If the return on investment during one calendar month is two percent, then the annualized return on that investments is determined to be twenty-four percent.
One of the benefits of calculating the annualized return is that it provides a broader picture of an investment’s performance than is possible to achieve with the consideration of a a single year return. Depending on the number of periods considered, the investor may find that the data indicates an investment that is not doing well at present has in fact posted a significant average return over the last several years, in spite of various ups and downs in the marketplace. As result, the investor may find that holding on to the investment may be a wiser decision that selling it, since there is a good chance it will increase in value once again and continue to earn a decent rate of return over an extended time period.