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What is annualized rate of return?

The Annualized Rate of Return (ARR) is a measure used to calculate the average annual return on an investment over a specific period of time. It provides a standardized way to compare the performance of different investments or assess the overall profitability of an investment.

To calculate the annualized rate of return, the following formula is commonly used:

ARR = [(Ending Value / Beginning Value)^(1/n) – 1] * 100

In this formula, “Ending Value” represents the final value of the investment, “Beginning Value” represents the initial value of the investment, and “n” represents the number of years or periods the investment was held.

For example, let’s say you invested $10,000 in a stock and after three years, the investment grew to $13,000. To calculate the annualized rate of return, you would use the formula as follows:

ARR = [(13,000 / 10,000)^(1/3) – 1] * 100

The result would be the annualized rate of return over the three-year period.

The annualized rate of return allows investors to compare the performance of different investments, taking into account the time period over which they were held. It enables them to assess the average annual growth or loss rate on their investment, which helps in evaluating investment choices and making informed decisions.

It’s important to note that the annualized rate of return assumes a constant rate of growth or loss over the investment period, which may not reflect the actual fluctuations and volatility experienced. Additionally, the ARR does not take into account other factors such as taxes, fees, and inflation, which can impact the overall investment returns.

When considering the annualized rate of return, it is advisable to use it in conjunction with other investment metrics and consult with financial professionals for a comprehensive evaluation of investment performance.