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Compound Annual Return

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The compound annual return shows the investment return, assuming the investment grew at the same rate every year. For example, suppose an investment grew from $4,000 to $8,000 over four years. The total return is (($8,000-$4,000)/$4,000), or 100%, and the simple annual return is 100%/4, or 25%. The compound annual return, in contrast, compounds the annual increment in value each year. The formula for the compound annual return is ((Ending Value) /(Beginning Value))^(1/Number of years)-1. Thus the compound annual return is (($8,000/$4,000))^(1/4)-1, which equals 18.9%. (To determine the compound annual return, plug the equation directly into Google and click Search.) Because the compound annual return includes each year's increment, its rate will always be lower than the simple return. The compound annual return doesn't indicate whether the investment actually grew at such an even rate. But for comparing different investments over time, the compound annual return is useful.



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