Yearly Rate of Return Method
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What is the Yearly Rate of Return Method?
The yearly rate of return method calculates an investor’s return over an entire year. The formula is similar to the formula used to calculate the simple rate of return (ROR). Hence, it is calculated by subtracting the price of an investment (e.g., fund) at the beginning of the year from the price of the fund at the end of the year (value difference), then dividing this difference by the price of the fund at the beginning of the year.
Formula of the Yearly Rate of Return
Example - the Calculation of the Yearly Rate of Return
Let’s assume that a share’s price at the beginning of the year was CHF 100 and the price now at the end of the year is CHF 120. Therefore, the increase of the price is CHF 20. Calculating the percentage increase of the share value, and therefore the yearly rate of return, involves dividing the increase of the price by the price at the beginning of the year, and multiplying the result by 100. In this simple example, the yearly rate of return is 20%. Note that no dividends were paid. As dividends represent a part of the return, it is important to consider them when calculating the yearly rate of return.
Other Rate of Return Measures
The yearly rate of return refers only to the percentage change in price over a single year. The formula’s simplicity is a clear advantage. However, the formula does not take into account growth rates. Additionally, investment opportunities may not have the same maturity, so comparing returns may be difficult. Furthermore, cash flows are not considered. In this regard, alternative rate of return formulas may be more appropriate depending on the investment opportunity.
The annualized rate of return is an alternative to the yearly rate of return. Maturity periods differ from one investment to another. The annualized rate of return method converts the maturities of the various investments to a year. Therefore, investors can use this method to compare the returns of investment opportunities.
Another option is the calculation of the time-weighted rate of return and the money-weighted rate of return. The calculation of these returns is popular among asset managers, who wish to evaluate the performance of investment portfolios. The money-weighted rate of return considers cash flows, whereas the time-weighted rate of return takes growth rates into account.
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