Primary navigation:

QFINANCE Quick Links
QFINANCE Topics
QFINANCE Reference
Add the QFINANCE search widget to your website

Home > QFINANCE Dictionary > Definition of rate of return

Definition of

rate of return

Accounting

ratio of investment profit to investment cost an accounting ratio of the income from an investment to the amount of the investment, used to measure financial performance.

There is a basic formula that will serve most needs, at least initially:

[(Current value of amount invested − Original value of amount invested) / Original value of amount invested] × 100% = Rate of return

If $1,000 in capital is invested in stock, and one year later the investment yields $1,100, the rate of return of the investment is calculated like this:

[(1,100 − 1,000) / 1,000] × 100% = 100 / 1,000 × 100% = 10%

Now, assume $1,000 is invested again. One year later, the investment grows to $2,000 in value, but after another year the value of the investment falls to $1,200. The rate of return after the first year is:

[(2,000 − 1,000) / 1,000] × 100% = 100%

The rate of return after the second year is:

[(1,200 − 2,000) / 2,000] × 100% = −40%

The average annual return for the two years (also known as average annual arithmetic return) can be calculated using this formula:

(Rate of return for year 1 + Rate of return for year 2) / 2 = Average annual return

Accordingly:

(100% + −40%) / 2 = 30%

The average annual rate of return is a percentage, but one that is accurate over only a short period, so this method should be used accordingly.

The geometric or compound rate of return is a better yardstick for measuring investments over the long term, and takes into account the effects of compounding. This formula is more complex and technical.

The real rate of return is the annual return realized on an investment, adjusted for changes in the price due to inflation. If 10% is earned on an investment but inflation is 2%, then the real rate of return is actually 8%.

Related definitions of "rate of return"

Recommended Further Reading (Term count)
  • Understanding and Accessing Private Equity for Small and Medium Enterprises
    by Arne-G. Hostrup
    Private equity is the generic term for all forms of financing through external equity capital in the broader sense. The generic term is often subdivided into:Venture capital (VC) is made available by business angels (who provide so-called informal venture capital, or IVC) and venture capital companies, usually management companies with a venture capital fund under administration. VC is made use of in a company’s early stages—from foundation,...
  • Capital Adequacy Requirements for Islamic Financial Institutions: Key Issues
    by M. Kabir Hassan, Ebid Smolo
    The Islamic financial industry (IFI) has grown tremendously in the last two to three decades. In short, Islamic finance refers to financial activities that are guided by the teachings of shariah (Islamic law), which strictly prohibits the payment and receipt of interest. Today, Islamic finance attracts both Muslim and non-Muslim market participants. The worldwide market for shariah-compliant Islamic financial products is estimated to be between...
  • James Tobin
    American economist proponent of Keynesian economics
    James Tobin was a renowned economist, writer, and Nobel Prize winner, known for his work on portfolio theory, Keynesian economics, Tobin’s q, and the Tobit Model. He taught at Yale for many years, and researched and wrote primarily on macroeconomic issues, as well as working as an economics expert, and policy consultant. He was a member of President Kennedy’s Council of Economic Advisors, served two terms as president of the Cowles Foundation,...
  • Value at Risk
    Value at risk (VAR) is a useful tool for anyone looking to quantify the risk of a particular project or investment opportunity by measuring the potential loss that might be incurred over a certain period of time. VAR measures what is the most that an investor might lose, based on a specific level of confidence, over a specific period of time. For example, “What’s the most I can—with a 95% level of confidence—expect to lose over the next 12...

Definitions of ’rate of return’ and meaning of ’rate of return’ are from the book publication, QFINANCE – The Ultimate Resource, © 2009 Bloomsbury Information Ltd. Find definitions for ’rate of return’ and other financial terms with our online QFINANCE Financial Dictionary.

Back to top

Related Blog Posts

More related Blog results