How to Annualize Monthly Returns

An investment’s rate of return is its change in value over a period of time or a number of periods. It's typically expressed as a percentage, and it can be positive or negative. A higher return results in greater profit.

An investor might want to compare different investments, such as mutual funds or stocks, using their annual returns as an equal measure. You can annualize the return if you know an investment’s return for a period that is shorter than one year, such as one month. This converts the monthly return into an annual return or year return, assuming the investment doesn’t experience a great deal of volatility and would compound, or grow, at the same monthly rate.

You can do the same with daily returns, calculating them into monthly returns then annualizing them.

Annualized returns are a means of valuation that tell you how much an investment has lost or gained over an investment period of a year, according to Investor.gov. The rate of return can be calculated in any one of several ways, but it's often done on a monthly basis.

In simplest terms, multiplying the monthly number by 12 can tell you the annual rate of return. Likewise, dividing the annual rate by 12 gives you the monthly rate. However, the annual rate can be more pertinent when it comes to determining how your investment is performing, particularly when it's compared to overall performance.

The Teachers Insurance and Annuity Association (TIAA) gives this example: You invest $100 and it grows to $125 over a period of five years. Overall, you've achieved a return of 25 percent. But your return on an annual basis (your annualized return) is only 5 percent, or 25 percent divided by the five years. Annualizing puts the investment's performance into real perspective.

Tracking returns on an ongoing basis is important because it helps you stay on top of how an investment is performing. An annualized return gives you a snapshot of your entire year, which can be especially helpful if you're monitoring an entire portfolio return of investments. This annual figure can also be compared to other years to show your return on investment over the long term, according to TIAA.

You'll need your monthly returns in front of you to get started.

• First, substitute the decimal form of an investment’s return for any one-month period into the following formula: ‌[((1 + R)^12) - 1] x 100‌. Use a negative number for a negative monthly return. In the formula, the R represents the decimal form of the investment’s one-month return, and 12 represents the number of months in a year.

• Add the numbers inside the parentheses. In this example, add 1 to 0.02 to get 1.02. This leaves ‌[(1.02^12) - 1] x 100‌. Raise the number in parentheses to the power of its exponent: Raise 1.02 to the 12th power to get 1.268. This leaves (1.268 - 1) x 100. Subtract the numbers in parentheses: Subtract 1 from 1.268 to get 0.268. This leaves 0.268 x 100.
• Multiply the remaining numbers to calculate the annualized monthly return as a percentage. Continuing with the example, multiply 0.268 by 100 to get a 26.8 percent annualized return. This means that the investment would would generate a 26.8 percent annual return if it grew at a 2 percent monthly rate for a period of one year.

All this math might seem intimidating at first glance, but the Corporate Finance Institute points out that it's a surefire way to pin down performance over a number of years. This is especially useful when your investments experience a fair bit of volatility or you're comparing different types of investments and figuring out where your money is earning you the best return.You can also simply plug the completed formula into a tool such as Excel and save yourself from doing the calculation manually.

You can also compare the average return in one year to another year of performance for the same investment using the compound annual growth rate or CAGR. But that’s going to require a whole lot more math.