In order to express a result obtained from an investment made, the annualized return it is an effective option that offers the possibility of achieving this objective. The operation requires applying some contexts and the formula, which will be detailed in this information.
Expression of all the benefits obtained
What is annualized return?
The annualized return is the method of expressing a benefit obtained in a year, which is given from an investment made. It is expressed as a percentage value which can be calculated from operations with a considerable level of complexity, therefore, it is necessary to have knowledge in it so that errors are avoided since on many occasions it is usually confused with another profitability.
In this case, the calculation is based on the use of the geometric mean, which is a remarkable fact since the arithmetic mean is generally used, which means that in this operation a quotient between the benefits obtained should not be made. and the time in which the investment was made. The method in this case is different, in order to obtain the percentage result it is necessary to use a formula that has some difficulty, which is:
In order to use the formula correctly, it is necessary to know the data to be used. The 'a' is the profitability that was obtained in one year and the 'n' is the number of years that this process took. As it is a mathematical operation that can express great difficulty, one of the options that people carry out to carry it out is to use the Excel program, since it has functions that make it much easier.
A fact that is essential to mention is that when calculating a total return it is not possible to carry out the sum of the returns per year, in this case a multiplication is made, for this the application must be that of a compound interest. As time passes and this calculation is carried out, an exponential result of the investment made will be obtained, since when one year is obtained, it also expresses the previous ones.
Example
Understanding how the calculation of the annualized return is of the utmost and vital importance, for this reason, the Standard & Poor's 500 ORANGE Fund will be detailed as an example, to make it much simpler. For this, the data presented, the year and the profitability will be highlighted: In 2013 24,64%, 2014 27,32%, 2015 11,03%, 2016 13,38%, 2017 6,34% , 2018 -1,46%. From these data, calculate the annualized return in six years.
Applying the formula, it is obtained as follows: ((1+0,2464)*(1+0,2732)*(1+0,1103)*(1+0,1338)*(1+0,0643) *(1-0,0146))^(1/6)-1 = 13,19%. The result obtained indicates the annualized return that the ORANGE Fund Standard & Poor's 500 presented in those six years. As can be seen, the method is quite simple and useful, there is no greater complexity, but it is necessary to have knowledge of certain contexts applied in the formula. otherwise it will generate errors.
Advantages
The benefits it offers is the possibility of knowing in detail how is the return given by a fund that has been invested, since, when a person carries out this type of action, they must make projections for their economic stability, however, it is complex to know if the earnings will be optimal or not, however, based on the annualized return, the percentage will be a term that indicates a status.
In addition, when these values are used, there is the possibility of making comparisons, it is a very useful technique to be able to say which action is the correct one to carry out, among them being able to relate it directly to the time it will last. They are data that help a person to fully visualize their business, considering positive and negative aspects, which allows them to improve to obtain optimal results.
When it is related to the financial area in general, it is important to have knowledge of all the related elements, which may also require calculations, where it is known how to distribute expenses and more, we recommend you read about the amortization
Limitations
It is noteworthy to take into account that not all aspects are positive, there are certain limitations which must be considered when using this operation, the main thing is that the annualized return does not indicate the variance that is exhibited in periods of time. , which is usually a highly required piece of information. Therefore, it is required to be aware that its results indicate that in long periods of time both profits and losses can occur.
For this reason, a high disadvantage of the annualized return is exhibited, it will not be possible to know exactly in what time the investment made can be recovered. This is a very important piece of information that people in the commercial area require since it is necessary to establish a control of its production and to know if it is really effective. Similarly, the use of this profitability is noteworthy, but it is an aspect that must be taken into account, because it is usually needed to carry out each of the steps in the economic field.
Important aspects
The calculation of the profitability of an investment can be carried out in different ways, it is important to take into account that these are not the same, for this, different points must be considered, such as, for example, that the benefit obtained is not the total profitability, it is one of the most common errors, for these cases it is necessary to consider the amount invested at the beginning of the process, since with this data the resulting profit can be known.
When the analysis of the profitability of an investment is carried out, it is necessary that it be expressed as a percentage directly related to the first contribution made, taking into account that it can be both a profit and a loss. This data obtained is known as simple profitability, and it is very easy to do, in order not to make any mistakes or generate confusion, certain steps must be followed.
First, the sum of all the profits must be made, the value obtained from the sale is considered as well as each of the dividends that are highlighted from the collection. Then each one of the expenses is subtracted as well as the investment that was carried out initially, which means that the result obtained in the first step is subtracted from the price at which the share was bought as well as the expenses.
As a third step, the amount obtained must be divided by the value of the investment that was made at the beginning of the process, then what is obtained is multiplied by 100% so that the value is a percentage. This is the operation that is applied to obtain the simple return, which is expressed as follows: RS = (Final value + Returns – Expenses – Initial investment) / Initial investment.
The confusion is usually generated when investments are made that are not short-term, in which time horizons are expressed, then they are made in the long term, so that the returns of different years can be analyzed, the applied comparison will show different results and from a profitability simple, the meaning of this cannot be known, the annualized return does provide a solution
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In the financial area there are many points that must be taken into account, such as being able to express the benefits obtained or some type of expense incurred, among them the protection of finances is of high importance, it is recommended to read about diversify investments