How To Calculate an Annualized Rate of Return

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The annualized rate of return is used by analysts and investors to compare the rates of return between investments with different maturity lengths. For example, just by looking at the overall returns you could not tell the difference between a certificate of deposit that returned a total of 20 percent over five years and a stock that returned a total of 12 percent over three years. However, if you use the steps below, you can determine how much the rate of return for each investment is per year so you can accurately compare the two options.

Things You'll Need

  • Calculator
  • Determine the initial investment required. Some investments like annuities may require a minimum investment while others, like stocks, usually allow you to invest as much or little as you want.

  • Determine the length of the investment in years. An investment of 18 months would be 1.5 years.

  • Estimate how much your contribution will be worth at the end of the investment, also known as the maturity. Some investments like an annuity will have a scheduled payout that you can use. Others, like stocks, require you to predict the future value.

  • Use the following formula where I is the investment amount, M is the value at maturity and Y is the number of years.

    Annualized Rate of Return = (1 + M / I) ^ (1 / Y) - 1
    An investment that costs $10,000 and will be worth $15,000 in five years would have an annualized rate of return of just over 20 percent.

Tips & Warnings

  • The annualized rate of return is not the only factor to consider when determining what to invest in. Also consider how much risk is involved and how easily you can access your money should an emergency arise.

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