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Annual Profit

The return on an investment computed as a percentage of the initial investment over the course of a year.

By cheap accountantPublished 2 months ago 3 min read
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What exactly is an annual return?

The annual return is the return on an investment computed as a percentage of the initial investment over a year. If the return is positive (negative), the initial investment is deemed a gain (loss). The rate of return will vary according on the level of risk.

Formula for Annual Return

The following formula calculates an investment's return over a 12-month period:

Formula for Annual Return

All interest and dividends paid over the 12-month period should be reflected in the investment's ultimate value.

Example of an Annual Return

Assume you buy 200 shares at a cost of $10 per share. After one year, you receive 1 in cash dividends, and the stock is now worth $9.50. How can you assess the performance of an investment made a year ago?

It is acceptable to conclude that the investment is profitable if the return is positive. Let's figure out the annual return. As an example:

1. The initial investment value

Initial investment value = $10 x 200 = $2,000

2. The investment's total worth

After a year, you will have cash from dividends and 200 shares worth $9.50. Hence,

Dividends received = $1 x 200 = $200

Current share value = $9.50 x 200 = $1,900

The total cost of the investment is $200 + $1,900 = $2,100.

3. Annualized return on investment

Calculation of Samples

Annualized Profit

In the preceding example, we calculated the return on investment for a single 12-month period. In practise, though, you invest your money in different assets across different time periods. You must annualize the returns on such investments in order to compare them to a one-year return. The annualised return is the rate of return each year measured over a period longer or shorter than a year.

Because the annualised return includes compounding, it is also known as the Compound Annual Growth Rate (CAGR).

Formula for Annualized Returns

Depending on the information available, there are two ways to calculate the annualised return.

Option 1: Given the annual returns for each year of the investment period, you should:

Option 1 of the Formula

Where:

R1 is the annual return for the first year, R2 is the yearly return for the second year, and so on.

n - The number of years to annualize.

For example, suppose you bought 200 shares at $10 apiece and planned to hold them for three years. The stock grows 10% this year, 14% the following year, and declines 15% the following year. What was the rate of return on your investment over the last three years?

R1 = 15%, R2 = 14%, and R3 = -10% in this case.

Calculation of Samples

As a result, you earned a 5.67% yearly return on your investment.

Option 2: When given a monetary value for returns rather than an annual rate of return, then:

Option 2 for the Formula

Where:

n - The number of years to annualize.

For example, suppose you bought 200 shares at $10 apiece and planned to hold them for three years. Each year, you receive $1 in cash dividends each share. You decide to sell all of your shares at $12 after three years. What was the rate of return on your investment over the last three years?

It is worth noting that the monetary value of the investments is provided here.

1. The initial investment value

Initial investment value = $10 x 200 = $2,000

2. The investment's total worth

Dividends received during a three-year period = $1 x 200 x 3 years = $600

Value of the shares sold = $12 x 200 = $2,400

The total cost of the investment is $600 + $2,400 = $3,000

3. Annualized return on investment

Annualized Return Rate

As a result, your investment yielded an annualised return of 14.47%.

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