What Is Annualized Total Return?

What Is Annualized Total Return?

Let me explain annualized total return directly: it's the average annual return an investment generates over several years, calculated as a geometric average to show what you'd earn if the returns compounded each year.

This metric gives you a quick view of performance, but remember, it doesn't tell you about the investment's volatility or how prices swung during that time.

Understanding Annualized Total Return

To get a clear picture, consider two mutual funds over five years. Fund A had returns of 3%, 7%, 5%, 12%, and 1%. Fund B had 4%, 6%, 5%, 6%, and 6.7%.

Both end up with a 5.5% annualized return, but look closer: Fund A is more volatile with a 4.2% standard deviation, while Fund B's is just 1%. Depending on your holding period and goals, that volatility matters a lot.

Annualized Return Formula and Calculation

The formula is straightforward—you need the returns and the holding time. It's: Annualized Return = [(1 + r1) × (1 + r2) × ... × (1 + rn)]^(1/n) - 1.

For Fund A: Plug in the values and you get [(1 + 0.03) × (1 + 0.07) × (1 + 0.05) × (1 + 0.12) × (1 + 0.01)]^(1/5) - 1 = 5.53%.

It doesn't have to be yearly; for non-annual periods, use: Annualized Return = (1 + Cumulative Return)^(365 / Days Held) - 1.

Say you held a fund for 575 days with 23.74% cumulative return: (1 + 0.2374)^(365/575) - 1 = 14.5%.

Difference Between Annualized Return and Average Return

Average return is simple: sum the returns and divide by the number of periods. But annualized return factors in compounding by using the geometric mean, so it's usually lower and more realistic for showing actual performance.

Reporting Annualized Return

Under GIPS standards, you can't annualize performance for investments with less than 365 days of history. For example, a six-month 5% return can't be called 10% annualized—that's predicting, not reporting facts.

How Is Annualized Total Return Calculated?

It's the geometric average capturing average annual performance with compounding, also known as CAGR.

What Does 3-Year Annualized Return Mean?

It means the calculated return rate over exactly three years.

Is 10% Annualized Return Good?

That depends on your goals, timeline, and strategy—some see 10% as solid, others aim higher.

The Bottom Line

Annualized total return gives you the geometric average yearly earnings over a period, accounting for compounding, but it skips details on volatility—so use it as one tool in your analysis.