First up we discuss about annualized returns. An annualized total return is the geometric average amount of money earned by an investment each year over a given time period. It is calculated as a geometric average to show what an investor would earn over a period of time if the annual return was compounded.
That’s a mouthful, lets break this down. What is this geometric average that we talk about?
Annualized returns can sometimes be called CAGR, which means compounded annual growth rate. So in this formula, we plug in the variables and solve for CAGR.
CAGR considers compounding effect of money. This year you may profit $2000. We assume you have intention to reinvest this $2000 and compound it as part of your on-going investment journey. It is really important when we are comparing across different investments. Most rates or investment results are expressed as CAGR. So by expressing your returns as CAGR, you can compare apple to apple.
This calculation gets more complicated if we were to consider adding in adding in more money if you were to be running a real portfolio. If you were running a real portfolio, we have to use time weight return which is really much more complex. For now, don’t worry about that. We only have to know the simpler concept of CAGR annualized returns where we do not add or take away money from our portfolio during the investment.