Average Annual Return (AAR)

Editorial Chief

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October 24, 2023

Published

Average Annual Return (AAR), also known as Average Annualized Return or simply Annualized Return, is a financial metric used to measure the average annual performance or return on an investment over a specified period. It provides a way to express the average return on an investment on an annual basis, which makes it easier to compare the performance of different assets or investment strategies.

 

How is an Average Annual Return (AAR) calculated?

AAR is calculated by determining the total return generated by an investment over a given period and then annualizing that return to express it on a per-year basis.

 

The formula for calculating AAR is as follows:

AAR = [(Total Ending Value / Total Beginning Value) ^ (1 / n) – 1] * 100

 

Where:

  • Total Beginning Value is the initial value of the investment.
  • Total Ending Value is the final value of the investment.
  • “n” is the number of years in the investment period.

 

Illustration of how to calculate the Average Annual Return (AAR):

Let’s say you invested $10,000 in a cryptocurrency at the beginning of the year, and at the end of the year, your investment has grown to $14,000. To calculate the AAR for this investment over one year, follow these steps:

1. Collect Data:
– Initial Investment (Total Beginning Value): $10,000
– Final Investment Value (Total Ending Value): $14,000
– Investment Period (n): 1 year

 

2. Apply the Formula:

AAR = [(Total Ending Value / Total Beginning Value) ^ (1 / n) – 1] * 100
AAR = [($14,000 / $10,000) ^ (1 / 1) – 1] * 100

 

3. Calculate:

AAR = [($1.4) ^ 1 – 1] * 100
AAR = (1.4 – 1) * 100
AAR = 0.4 * 100
AAR = 40%

 

So, in this example, the Average Annual Return (AAR) for your investment in the cryptocurrency over one year is 40%. This means that, on average, your investment grew by 40% per year over that period. It’s a measure of the annualized return on your investment.

 

Use Cases:

  • Performance Assessment: AAR is a fundamental metric for assessing the performance of an investment, portfolio, or trading strategy over a specified period. It helps investors and analysts understand how much their investments have grown or declined on an average annual basis.
  • Comparison Tool: AAR provides a standard way to compare the returns of different investments. Investors can use it to evaluate the relative performance of various assets, mutual funds, or investment strategies.
  • Goal Tracking: AAR can be used to assess whether an investment is meeting specific financial goals or objectives. It allows investors to evaluate whether their returns are in line with their expectations and requirements.
  • Risk-Adjusted Returns: In combination with other metrics, AAR can help in assessing risk-adjusted returns. By comparing the AAR of an investment with its level of risk, investors can make more informed decisions.

 

Average Annual Return (AAR) is a valuable metric for assessing the historical performance of an investment or portfolio on an annualized basis. It’s widely used for comparing investment options and tracking progress toward financial goals, but it’s important to consider the limitations and the context in which it’s applied.