The yearly rate of return method, often termed the annual percentage rate, is a calculation that determines the amount earned on an investment over the span of a year. Calculated by dividing the amount gained or lost at the year’s end by the initial investment, it effectively indicates performance over that year. This metric is also known as the annual rate of return or the nominal annual rate.
Key Insights
- The yearly rate of return is computed by comparing investment values at the end and beginning of the year.
- This metric takes into account both capital appreciation and any dividends paid.
- While it provides insight into a single year’s performance, it does not capture potential compounding effects over multiple years.
The Formula for Yearly Rate of Return
The calculation for the yearly rate of return can be expressed with the following formula:
Yearly Rate of Return = ((EYP - BYP) / BYP) x 100
Where:
- EYP = End of year price
- BYP = Beginning of year price
Illustrative Example
Imagine a stock starts the year at $25.00 per share and ends the year at $45.00 per share. This stock would have an annual rate of return of 80.00%. This is determined by:
- Subtracting the end of year price from the beginning price: $45 - $25 = $20
- Dividing the difference by the beginning price: $20 / $25 = 0.80
- Converting the result into a percentage: 0.80 x 100 = 80.00%
Note that this calculation represents capital appreciation, one source of a stock’s return. Should this stock also pay $2 in dividends, the total rate of return would include these dividends, increasing it to roughly 88.00% over the one-year period.
A Broader Perspective on Return Measures
Other common return metrics can provide more nuanced views over time, particularly when considering the power of compounding. Adjustments for various time periods enhance the accuracy of such return measurements. Asset managers may utilize money-weighted and time-weighted returns to evaluate investment performance, with each having different focal points:
- Money-Weighted Rate of Return: Focuses on cash flows
- Time-Weighted Rate of Return: Examines the compound rate of portfolio growth
Certification and Professional Standards
The financial industry continually strives towards transparency and clear communication of performance to investors. Organizations like the CFA Institute offer credentials, such as the Certificate in Investment Performance Measurement (CIPM), fostering specialized expertise and standards in performance evaluation and reporting.
Related Terms: capital appreciation, dividend yield, compounding, money-weighted return, time-weighted return.
