The average rate of return is an investing concept that shows how much an investment made over the investment's life. The formula averages the return on a per year basis. It is important for investors to calculate their average return so they can make better comparisons between the returns of different investments.
Determine the investment's original cost and the selling price of the investment. For example, a person purchases 100 shares of stock on January 1, 2005 for $40 each, then sells all 100 shares on December 31, 2009 for $65 a share. His original cost is $4,000 and his selling price is $6,500.
Determine the rate of return on the investment by dividing the gain (the difference between the selling price and the original cost) by the original cost. In our example, $1,500 divided by $4,000 equals a return of 37.5 percent.
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Determine the number of years the investor kept the investment. In our example, the investor held the stock for five years.
Divide the rate of return by the number of years the investor held the shares to calculate the average rate of return. In our example, 37.5 percent divided by 5 years equals 7.5 percent per year.