What Is the Average Annual Return (AAR)?
The average annual return (AAR) is a percentage used when reporting the historical return, such as the three-, five-, and 10-year average returns of a mutual fund. The average annual return is stated net of a fund's operating expense ratio. Additionally, it does not include sales charges, if applicable, or portfolio transaction brokerage commissions.
In its simplest terms, the average annual return (AAR) measures the money made or lost by a mutual fund over a given period. Investors considering a mutual fund investment will often review the AAR and compare it with other similar mutual funds as part of their mutual fund investment strategy.
Key Takeaways
- The average annual return (AAR) is a percentage that represents a mutual fund's historical average return, usually stated over three-, five-, and 10 years.
- Before making a mutual fund investment, investors frequently review a mutual fund's average annual return as a way to measure the fund's long-term performance.
- The three components that contribute to the average annual return of a mutual fund are share price appreciation, capital gains, and dividends.
Understanding the Average Annual Return (AAR)
When you are selecting a mutual fund, the average annual return is a helpful guide for measuring a fund's long-term performance. However, investors should also look at a fund's yearly performance to fully appreciate the consistency of its annual total returns.
For example, a five-year average annual return of 10% looks attractive. However, if the yearly returns (those that produced the average annual return) were +40%, +30%, -10%, +5% and -15% (50 / 5 = 10%), performance over the past three years warrants examination of the fund’s management and investment strategy.
Components of an Average Annual Return (AAR)
There are three components that contribute to the average annual return (AAR) of an equity mutual fund: share price appreciation, capital gains, and dividends.
Share Price Appreciation
Share price appreciation results from unrealized gains or losses in the underlying stocks held in a portfolio. As the share price of a stock fluctuates over a year, it proportionately contributes to or detracts from the AAR of the fund that maintains a holding in the issue.
For example, the American Funds AMCAP Fund’s top holding is Netflix (NFLX), which represents 3.7% of the portfolio's net assets as of Feb. 29, 2020. Netflix is one of 199 equities in the AMCAP fund. Fund managers can add or subtract assets from the fund or change the proportions of each holding as needed to meet the fund's performance objectives. The fund's combined assets have contributed to the portfolio’s 10-year AAR of 11.58% through Feb. 29, 2020.
Capital Gains Distributions
Capital gains distributions paid from a mutual fund result from the generation of income or sale of stocks from which a manager realizes a profit in a growth portfolio. Shareholders can opt to receive the distributions in cash or reinvest them in the fund. Capital gains are the realized portion of AAR. The distribution, which reduces share price by the dollar amount paid out, represents a taxable gain for shareholders.
A fund can have a negative AAR and still make taxable distributions. The Wells Fargo Discovery Fund paid a capital gain of $2.59 on Dec. 11, 2015, despite the fund having an AAR of negative 1.48%.
Dividends
Quarterly dividends paid from company earnings contribute to a mutual fund's AAR and also reduce the value of a portfolio's net asset value (NAV). Like capital gains, dividend income received from the portfolio can be reinvested or taken in cash.
Large-cap stock funds with positive earnings typically pay dividends to individual and institutional shareholders. These quarterly distributions comprise the dividend yield component of a mutual fund's AAR. The T. Rowe Price Dividend Growth Fund has a trailing 12-month yield of 1.36%, a contributing factor to the fund’s three-year AAR of 15.65% through Feb. 29, 2020.
Special Considerations
Calculating an average annual return is much simpler than the average annual rate of return, which uses ageometric average instead of a regular mean.The formula is: [(1+r1) x (1+r2) x (1+r3) x ... x (1+ri)](1/n)- 1, where r is the annual rate of return and n is the number of years in the period.
The average annual return is sometimes considered less useful for giving a picture of the performance of a fund because returns compound rather than combine. Investors must pay attention when looking at mutual funds to compare the same types of returns for each fund.
FAQs
For example, if you invested $10,000 and it grew to $12,500 over a period of three years, the AAR would be calculated as: (12,500 / 10,000)^(1/3) - 1 = 0.081 or 8.1%. 3. Importance of AAR: AAR provides investors with a standardized measure to compare the performance of different investments over the same time period.
How do you calculate the AAR? ›
There are three steps to calculating the AAR. First, determine the average net income of each year of the project's life. Second, determine the average investment, taking depreciation into account. Third, determine the AAR by dividing the average net income by the average investment.
How do you calculate average annual return? ›
For instance, suppose an investment returns the following annually over a period of five full years: 10%, 15%, 10%, 0%, and 5%. To calculate the average return for the investment over this five-year period, the five annual returns are added together and then divided by 5. This produces an annual average return of 8%.
What is the AAR annual return? ›
The average annual return (AAR) is a percentage that represents a mutual fund's historical average return, usually stated over three-, five-, and 10 years. Before making a mutual fund investment, investors frequently review a mutual fund's average annual return as a way to measure the fund's long-term performance.
How do you calculate the annual return give an example? ›
Example of calculating annualized return
To calculate the total return rate (which is needed to calculate the annualized return), the investor will perform the following formula: (ending value - beginning value) / beginning value, or (5000 - 2000) / 2000 = 1.5. This gives the investor a total return rate of 1.5.
What is the formula for average ARR? ›
ARR = Average Annual Profit / Average Investment
Where: Average Annual Profit = Total profit over Investment Period / Number of Years. Average Investment = (Book Value at Year 1 + Book Value at End of Useful Life) / 2.
How do you calculate ARR on a financial calculator? ›
Annual Recurring Revenue Formula (ARR)
The formula to calculate the annual recurring revenue (ARR) is equal to the monthly recurring revenue (MRR) multiplied by twelve months.
How do you calculate average annual rate? ›
Annual Average Growth Rate = [(Growth Rate)y + (Growth Rate)y+1 + … (Growth Rate)y+n] / N
- Growth Rate (y) – Growth rate in year 1.
- Growth Rate (y + 1) – Growth rate in the next year.
- Growth Rate (y + n) – Growth rate in the year “n”
- N – Total number of periods.
An annualized total return is the geometric average amount of money an investment earns each year over a given period. The annualized return formula is calculated as a geometric average to show what an investor would earn over some time if the annual return were compounded.
How is average annual income calculated? ›
Average household income is the total amount of income earned by all members of a household age 15 or older, whether they are related or not. The income of all households is then added together and divided by the total number of households, to determine the average.
Average Annual Return (AAR) The sum of the return rates of an investment over a given number of years divided by that number of years.
What is AAR for? ›
The After Action Review (AAR) process was developed by the military as a way for everyone to learn quickly from soldiers' experiences in the field. With this system, critical lessons and knowledge are transferred immediately to get the most benefit.
What is the difference between IRR and AAR? ›
There are two key differences between an IRR and an AAR. An IRR factors compounding into the calculation whereas an AAR does not take compounding into consideration. An IRR is time-sensitive. For example, the faster the distribution of returns, the higher the IRR will be when all other factors remain constant.
What is the correct formula for calculating return? ›
Key Takeaways. Return on investment (ROI) is an approximate measure of an investment's profitability. ROI is calculated by subtracting the initial cost of the investment from its final value, then dividing this new number by the cost of the investment, and finally, multiplying it by 100.
What is the annual return for dummies? ›
Annual rate of return (ROR) is the amount earned on an investment over a 12-month period, and is usually expressed as a percentage. That percentage can be positive or negative, depending on the amount gained or lost compared to the principal—the initial investment or beginning amount during the analyzed holding period.
What is the formula for the average rate of return? ›
Divide the average annual profit by the investment or asset's initial cost. Multiply the resulting decimal figure by 100 to see ARR in a percentage format.
What is the formula for the effect annual rate? ›
The formula for EAR is: EAR = (1 + i/n)^n - 1 where i is the stated interest rate as a decimal and n is the number of interest payments per year. The stated interest rate is typically given as a percentage so remember to divide that percentage by 100 to get the decimal version.
How do you calculate an ARR? ›
ARR formula is pretty straightforward: add to your total number of yearly subscriptions the total amount gained from expansion revenue, and then subtract the total amount lost due to customer churn (customers who cancelled their subscriptions). You can also multiply your MRR by 12.
What is the formula for accounts receivable value? ›
The pro forma accounts receivable (A/R) balance can be determined by rearranging the formula from earlier. The forecasted accounts receivable balance is equal to the days sales outstanding (DSO) assumption divided by 365 days, multiplied by 365 days.
How do you calculate AAR and ADR? ›
ARR is the sum of all revenue during the period, divided by the total number of rooms sold for the period. ADR is the average of each day's ARR/ADR for the period.
