Annualized return

Annualized return restates an investment's total return as the rate it would have earned per year. Because raw returns cover different spans — one fund reports a 3-month gain, another a 5-year gain — annualizing puts them on a common yearly footing so they can be compared apples to apples.

The simplest approach scales the return linearly: a 2% gain over one quarter is roughly 8% annualized (2% × 4). But the more precise method compounds. The annualized return formula is (1 + total return)^(1 ÷ n) − 1, where n is the number of years. For example, an investment that grows 33.1% over three years has an annualized return of (1.331)^(1/3) − 1 = 10% per year — noticeably less than the 11.03% you'd get by just dividing 33.1% by three, because compounding does part of the work each year.

For periods shorter than a year, the same logic runs in reverse: (1 + period return)^(periods per year) − 1. A 2% quarterly return compounds to (1.02)⁴ − 1 ≈ 8.24% annualized. Annualized figures assume the pace of return continues, which is why regulators generally prohibit advertising annualized numbers built from very short periods — they can wildly overstate what an investor should expect.

Annualized return shows up on the Series 65, Series 66, and Series 7 exams under performance measures and yield calculations. Know the compound formula, how annualized return differs from cumulative and average returns, and why a geometric (compounded) average is lower than an arithmetic average of the same yearly returns.