Rate of return. Rate of return is the gain or loss of an investment over a certain period of time. A positive rate of return means a gain on investment.
Meanwhile, a negative rate of return signals a loss on investment. The formula for calculating rate of return is ending value of the investment minus beginning value of the investment, all divided by the beginning value of the investment, times 100. Keep in mind that any sort of gains made during the investment period should be included. For example, if you bought a share at $10 and its current price is $15 and you received a dividend of $1, the dividend should be included in the formula.
That would mean that the rate of return for this investment would equal 15 plus 1 minus 10 all divided by $10 times 100. This equals a rate of return of 60%. Let's look at an example of rate of return. A retail investor decides to purchase 10 shares of Company A at a per unit price of $20. He holds on to the shares of Company A for two years.
In that time frame, Company A pays yearly dividends of $1 per share. After holding them for two years, he decides to sell all 10 shares of Company A at a price of $25. The investor would like to determine the rate of return during the two years he owned the shares. To find the rate of return, we need to first calculate the dividends the investor received over the two-year period.
The dividends are calculated as 10 shares times $1 for the dividend times two years, equaling $20 over the period. Then, we need to calculate the gain from selling the shares. This is calculated as 10 shares times $25 equaling $250.
Next, we need to calculate the cost of purchasing the shares, which is calculated by taking 10 shares and multiplying by $20 to equal $200. Now we can plug in all these numbers into the rate of return formula, which would be 250 plus 20 minus 200, all divided by 200 times 100, equaling 35%. That means the investor realized a 35% return on his shares over the two-year period.
When talking about rate of return, we also need to look at the annualized rate of return. Annualized rate of return is the rate of return specifically over one year. The formula for it is the ending value of the investment divided by the beginning value to the power of one over the number of years in the period minus one. Similar to the simple rate of return we covered earlier, any gains made, including dividends, need to be accounted for in this formula.
Let's look at an example of calculating annualized rate of return. We can use the same example as earlier, using the same numbers from before. The annualized rate of return is calculated as 250 plus 20 divided by 200 to the power of 1 over 2 years minus 1, which equals 16.19%.
This means that the investor made an annualized return of 16.19% or that he made 16.19% of return each year. Thank you for watching this video on rate of return. We hope you learned something new.