What is the annual average return, or AAR?

When presenting historical returns, such as the three-, five-, and 10-year average returns of a mutual fund, the average annual return (AAR) is a percentage that is utilized. The net yearly return of a fund is expressed after deducting the operating expense ratio. Furthermore, it excludes any brokerage commissions for portfolio transactions and sales costs.

The average annual return (AAR) is a primary metric that expresses how much money a mutual fund has gained or lost over a specific period. As part of their mutual fund investing strategy, investors debating a mutual fund investment will frequently examine the AAR and compare it to other mutual funds of a similar nature.

A Comprehensive Guide to Average Annual Return (AAR)

The average annual return is a valuable metric to gauge the long-term performance of mutual funds when choosing one. But to truly understand the stability of a fund’s annual total returns, investors should also consider the fund’s yearly performance.

For instance, a 10% average yearly return over five years seems appealing. Nonetheless, the performance during the previous three years justifies a review of the fund’s management and investment strategy if the yearly returns (those that generated the average annual return) were +40%, +30%, -10%, +5%, and -15% (50 / 5 = 10%).

The elements of an average yearly return (AAR)

An equity mutual fund’s average annual return (AAR) comprises dividends, capital gains, and share price increases.

Appreciation of Share Prices

Unrealized gains or losses in the underlying equities that comprise a portfolio cause increased share prices. Over one year, a stock’s fluctuating share price adds to or subtracts from the AAR of the fund that holds the stock.

As of February 29, 2020, Netflix (NFLX) accounted for 3.7% of the net assets in the American Funds AMCAP Fund, making it the fund’s most prominent investment. The AMCAP fund consists of 199 stocks, including Netflix. When necessary to achieve the fund’s performance goals, fund managers might add, remove, or alter the quantities of each holding from the fund. Up to February 29, 2020, the portfolio’s 10-year average annual rate of return (AAR) was 11.58%, thanks to the pooled assets of the fund.

Distribution of Capital Gains

Capital gains distributions from a mutual fund are made when an investor sells their equities for a profit in a growing portfolio or when income is generated. The shareholders can either receive the payouts in cash or reinvest them in the fund. The realized component of AAR is capital gains. The dividend constitutes a taxable gain for shareholders as it lowers the share price by the amount distributed.

A fund can make taxable distributions even if its AAR is negative. Despite having an AAR of – 1.48%, the Wells Fargo Discovery Fund earned a capital gain of $2.59 on December 11, 2015.

Refunds

A portfolio’s net asset value (NAV) is decreased, as is the annual percentage rate (AAR) of a mutual fund, by the quarterly dividends received from corporate earnings. Similar to capital gains, dividend income from the portfolio may be cashed out or reinvested.

Individual and institutional investors usually get dividend payments with favorable earnings from large-cap stock funds. The dividend yield portion of an AAR for a mutual fund is made up of these quarterly disbursements. The fund’s three-year average annual rate of return (AAR) of 15.65% through February 29, 2020, is partly explained by the T. Rowe Price Dividend Growth Fund’s trailing 12-month yield of 1.36%.

Extra Attention to Detail

Compared to the average annual rate of return, which is calculated using a geometric average rather than a normal mean, the average annual return calculation is more straightforward. It is calculated as follows: [(1+r1) x (1+r2) x (1+r3) x… x (1+ri)] Where n is the number of years in the period and r is the yearly rate of return, we get (1/n) minus 1.

Because returns compound rather than combine, the average yearly return is frequently seen as less helpful in illustrating a fund’s performance. Investors need to compare the same kinds of returns for each mutual fund while examining them.

Conclusion

• The historical average return of a mutual fund is represented by the average annual return (AAR), which is often expressed over three, five, and ten years.
• Investors often look to a mutual fund’s average yearly return before placing an investment to gauge the fund’s long-term performance.
• A mutual fund’s average yearly return comprises dividends, capital gains, and share price increases.