Yearly Rate of Return Method. MarketCheese

The yearly rate of return method, also known as an annual percentage rate, refers to the amount gained by an investor over a 12-month period. The yearly rate of return is determined by dividing the current capital (received or lost at the end of the year) by the initial sum, expressed in the form of a comparison of these two values.

Yearly Rate of Return Method explained

The yearly rate of return can be either positive or negative, and it depends on the final amount of capital, which is compared with the initial amount during the considered holding period. The analyzed period can start at the time of first investments and lasts until the end of a full year, or cover a calendar year.

For instance, on January 1, an investor bought 5 shares of a corporation. The value of each share was $100, so the investor made a total investment of $500. And after one year, the value of one share was $120, and they were sold for a total of $600. To find out the yearly rate of return, the investor deducted the price at the end of the year ($600) from the initial investment ($500), divided the result by the initial investment, then multiplied by 100. The investor made a yearly rate of return of 20.00%. The yearly rate of return = [($600 – $500) / $500] x 100 = ($100 / $500) x 100 = 20.00%.

If he received a $5 dividend for each share, then the formula is the following. Yearly total sum of dividends = 5 x $5 = $25. Yearly rate of return = [($600 + $25 - $500) / $500] x 100 = ($125 / $500) x 100 = 25.00%.

That is, in fact, the methods of earning an investor lie in capital gains and obtaining dividend yields. In addition, the yearly rate of return method determines the profitability of a capital expenditure by dividing expected annual net income by the average investment. The yearly rate of return technique is based directly on accounting data.

A bad point of the yearly rate of return method is the fact that the possibility of calculating compound interest over many years is not taken into account, and only one year is included in the calculation.

Methods other than the Yearly Rate of Return technique

To make specific calculations of compound interest over longer periods of time, other indicators of return are used, which act as an extension of the basic method of return and include an adjustment for discrete or continuous periods of time.

The following two measures can be used to identify productivity or rate of return of investments: the money-weighted concentrates on the flow of money, the time-weighted takes into account the aggregate growth rate of the investor's portfolio.

The CFA Institute, an international association of investment professionals, provides the professional Certificate in Investment Performance Measurement (CIPM). This CIPM plan was produced by the CFA Institute as a special certification plan that recognizes the performance evaluation and presentation experience of investment professionals.