An annualized return, also known as the compound annual growth rate, is used to measure the average rate of return per year when taking into consideration the effects of interest compounding. For example, if you have a 50 percent return over five years, the annualized return is less than 10 percent because of compounding. Interest compounding refers to how returns will produce additional returns in future years. To calculate the annualized return, you need to know the initial value, the final value, and the time you held the investment.
Step 1
Calculate the gain factor by dividing the final value of the investment by the initial value of the investment. For example, if you bought a stock for $50 and sold it for $80, you would divide $80 by $50 to get 1.6.
Step 2
Divide 1 by the number of years you held the investment. For example, if you held the stock four years, you would divide 1 by 4 to get 0.25.
Step 3
Raise the result from Step 1 to the power of the result from Step 2. "Raising" refers to using exponents, a shorthand way of saying to multiply a number by itself a certain number of times. For example, six to the third power would be six times six times six. In this example, you would use a calculator to raise 1.6 to the 0.25th power to get 1.12468265.
Step 4
Subtract 1 from the result from Step 3 to find the annualized rate of return expressed as a decimal. In this example, you would subtract 1 from 1.12468265 to get 0.12468265.
Step 5
Multiply the result from Step 4 by 100 to convert the annualized return from a decimal to a percentage. Finishing the example, you would multiply 0.12468265 by 100 to find an annualized return of about 12.5 percent per year.