Annual return in terms of trading terminology, is the return on trading funds that a trader or trading portfolio generates over a specific trading period, expressed as an annual percentage. The rate of annual return is expressed as a percentage of the total value of the fund or portfolio (the initial investment) and shows a geometric mean rather than an arithmetic mean.
A geometric mean is calculated from percentages derived from values whereas an arithmetic mean uses the actual values themselves to calculate the final result. The geometric mean must be used for calculating annual return as it takes into account the effect of compounding where the initial investment will increase (or possibly decrease) year on year.
Annual return is the standard or preferred method of calculating a return on investment for investments with liquidity and given that it is calculated using the geometric method, it will always take into account any increases in the portfolio value to produce a more accurate figure than just a simple return.
The formula for calculating annual return can be expressed as below:
Annual return=((final value/initial value)1/years)−1
Where years=number of holding years for the investment in the trading fund
Key takeaways:
- Annual return is a measurement of how an investment has performed (positively or negatively) on average each year and over a specific period.
- Annual return is calculated as a geometric average rather than an arithmetic average to take into account compounding.
- Annual return is one of the simplest methods of return assessment and is used worldwide by investors and fund managers.