What is an Annual Return?

Annual return refers to the percentage change in the value of an investment over one year. It reflects how much the investment has gained or lost in value, including any income such as dividends or interest. This metric helps investors understand the performance of their investments and is crucial for assessing their profitability.  
 

Understanding Annual Return 

The annual return is a key indicator of an investment's performance over one year. Here is a clearer view of what it entails: 

• A positive annual return indicates that the investment has grown in value, whereas a negative return means the investment has lost value. This measure reflects the net result of the investment's performance. 
• To provide a consistent measure over different periods, the annualised return (or Compound Annual Growth Rate, CAGR) is used. This represents the geometric average amount of money an investment earns annually over a given period, assuming the returns are reinvested. 
• Understanding the annual return helps investors evaluate how their investments are performing relative to benchmarks or other investment opportunities. It also assists in making informed decisions regarding asset allocation and future investments. 

 

Example of the Annual Return Calculation 

To illustrate how to calculate the annual return, follow this example: 

Assume you invested ₹50,000 in a mutual fund. After one year, the investment is valued at ₹55,000, and you receive ₹2,000 in dividends. 

The final value of the investment is the sum of the current investment value and dividends received. 

Final Value = ₹55,000 + ₹2,000 = ₹57,000 

Calculation: 

Annual Return = ((Final Value − Initial Investment) / Initial Investment) * 100% 

Annual Return = ((57,000 - 50,000) / 50,000) * 100% 

Annual Return = 14% 

This calculation shows a 14% annual return, indicating a positive performance of the investment over the year. 
 

How to Calculate Overall Return on an Investment 

Calculating the overall return involves assessing performance over multiple periods, using the annualised return or Compound Annual Growth Rate (CAGR). 

The formula for calculating annualised return is: 

Annualised Return = [((1 + R1) * (1 + R2) * (1 + Rn)) ^ (1 / N) – 1] * 100 

Where, 

N represents the total number of periods considered for measurement. 

R1 represents the annual return for the first year, R2 denotes the annual return for the second year, and so on. 

For instance, if you bought 200 shares at ₹10 each and held them for five years, with the stock increasing by 10% in the first year, and 14% in the second year. 

The overall rate of return for the five years: 

Annualised Return = [((1 + 10%) * (1 + 14%)) ^ (1 / 5) – 1] * 100 = 4.63% 

The annualised return on your investment over the five years is 4.63%. 

By using tools like a mutual fund annual return calculator, you can easily determine the annualised return and assess the growth of your investments.