When calculating an annual rate of return on an investment, there are three very important rules that must be followed: 1) When the income received is for an investment that was held for less than one full year, the amount of income must be annualized. We need to know “if this amount of principal had been invested for one full year at the same annual rate of return that it earned for the period it was held, what per-centage of the principal would the investor have received as income on the investment?” To annualize the income, we multiply the income by whatever factor is needed to express it as annual income. If the income is for six months, we multiply it by 2 because there are two 6-month periods in a year. If the income is for one month, we multiply it by 12 because there are twelve 1-month pe-riods in a year. 2) The “amount invested” used in the calculation must be the average balance of the amount invested during whatever period of time the funds were invested, up to one year. The amount invested can vary throughout the period it is invested. When that happens, the amount of income that will be re-ceived on that investment will vary. But an annual rate of return can still be calculated by dividing the total amount of income received (annualized, of course) by the average balance of the invest-ment during the period the income was earned. 3) If the funds were invested for less than one full year, we assume that the average balance during the period the funds were invested was the average balance for one full year, even though the invest-ment was not held for a full year.
Posted on: Wed, 24 Dec 2014 10:13:05 +0000
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