Measuring and monitoring the rate of return is one of the most important things you need to do for your investments. The rate of return can be calculated as
(New_Total - Original) / Original x 100%
For example:
(110 - 100) / 100 x 100% = 10%
However, understanding the rate of return is not as simple as your might think, since the number shown by others might be calculated differently than you would expect. The reason is that there are two ways to measure the rate of investment return.
Average annual return (average annual arithmetic return)
Average annual return is calculated by using the sum of annual returns divided by the number of years.
For example, your original investment is $100. After the first year, you lost 50% of your investment and it becomes $50. The next year, your investment doubled to $100. Using average annual return, your rate will be
( (50 - 100) / 100 x 100% + (100 - 50) / 50 x 100% ) / 2 = 25%
Therefore, even though your investment did not increase, you have an average return of 25%. Check out this site, for example:
Transamerica Science & Technology
If you have $10,000 on 5/1/2000 and it becomes about $5,000 on 6/30/2007. The page indicates an average annual returns of 12.76%.
Compound annual return (average annual geometric return)
Compound annual return is calculated by following formula:
( (New_Total - Original) ^ (1 / n) - 1 ) x 100%
Using the above example, the compound annual return will be 0%.
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