Investors always want to measure the returns various investments have achieved in the past, but often have different ways of doing so. One frequent difference is with regard to the time period used. An annualized return figures the investment's average annual return, while the absolute return measures the overall return for the entire time period you've held the investment.
The absolute return is measured by subtracting the investment amount from the sales price of the investment. If you still hold the investment, you use the current market value rather than the sales price. For example, say you paid $2,000 for a stock and it's now worth $2,200. Your absolute return is $200. The absolute return differs from a relative return because it is measured in pure profit or loss, whereas a relative return measures the return against a benchmark, such as the S&P; 500, that the fund is trying to beat.
Absolute Return Percentage
If you leave the absolute return as a raw number, it's hard to tell how well the investment actually did. For example, if someones tells you "I made $200 on my investment!" you wouldn't know whether they doubled their initial investment of $200, which would be impressive, or they actually invested $20,000 just to make $200, which would be, well, less than awe-inspiring. So, to account for the size of the investment, the absolute return can be converted to a percentage by dividing the return by the investment and multiplying by 100. For example, if you have a $200 return on a $2,000 investment, divide $200 by $2,000 to get 0.1, or a 10 percent return.
The annualized return gives an investment's average yearly return over a specified period of time. That way, you're comparing apples and apples -- you don't have to wonder whether the investment took 2 years or 20 years to make the money. To figure the raw annualized return, divide the absolute return by the number of years you held the investment. For example, if it took two years to make a $200 return, the annualized return is $100.
Annualized Return Percentage
Calculating the annualized return percentage requires some more complicated math because of the effects of interest compounding -- you can't just divide the percentage return by the number of years. Instead, first add 1 to the return expressed as a decimal. Next, raise the result to the power of 1 divided by the number of years. Last, subtract 1 from the result. For example, say you have a 10 percent return -- or 0.1 -- over two years. Add 1 to 0.1 to get 1.1. Then raise 1.1 to the 1/2 power to get 1.0488. Last, subtract 1 to find the annualized return percentage is 0.0488, or about 4.88 percent.
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