Detailed Explanation
Annualized Rate of Return (also called CAGR-Compound Annual Growth Rate) measures what consistent annual return would produce the same total growth as your actual investment. It smooths out year-to-year volatility into a single, comparable number.
The Formula
Annualized Return = (Ending Value / Beginning Value)^(1/years) - 1
Why Annualized Returns Matter
Problem: “I made 50%” doesn’t tell you much. 50% in 1 year vs 50% in 10 years is vastly different.
Solution: Annualized returns convert any investment period into a yearly rate for fair comparison.
Arithmetic vs. Annualized Average
They’re different-and it matters:
| Year | Return |
|---|---|
| 1 | +50% |
| 2 | -50% |
| Arithmetic average | (50-50)/2 = 0% |
| Actual result | $100 → $150 → $75 |
| Annualized return | -13.4% |
The arithmetic average misleads. Annualized return shows the truth.
Examples
Investment Comparison
| Investment | Start | End | Years | Total Return | Annualized |
|---|---|---|---|---|---|
| Stock A | $10,000 | $25,000 | 10 | 150% | 9.6% |
| Stock B | $10,000 | $18,000 | 5 | 80% | 12.5% |
| Stock C | $10,000 | $15,000 | 3 | 50% | 14.5% |
Stock C had the best annualized performance despite lowest total return.
S&P 500 Historical Performance
| Period | Total Return | Annualized |
|---|---|---|
| 2014-2024 | ~230% | ~13% |
| 2004-2024 | ~440% | ~8.8% |
| 1994-2024 | ~1,500% | ~9.8% |
Calculating Your Portfolio Return
$50,000 invested 5 years ago, now worth $73,000:
- Annualized = ($73,000/$50,000)^(1/5) - 1 = 7.9%
Why It Matters
Annualized returns are useful for investment analysis:
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Fair Comparison: Compare any two investments regardless of holding period.
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Realistic Expectations: Historical annualized returns help set reasonable expectations for projections.
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Performance Check: Are you beating or lagging the market? Annualized returns give the answer.
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Goal Planning: Knowing required annualized return helps determine if goals are realistic.
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Avoid Deception: Headlines say “market doubled in 10 years”-that’s only 7.2% annually.
Tracking your portfolio’s annualized return over time shows whether your investment strategy is actually working.