Average annual return is a metric created to evaluate long term investment performance. It allows the investor to look back at investments to see how they have performed through time, and also gives buyers a basis for projecting future performance as well. Astute investors will perform regular and systematic evaluations of their investments, and average annual return is a handy tool to help them do those. It is important to remember that this is just a number without much meaning if it is not examined in the context of the performance of the market overall for the selected time period.
As investors (and as humans), we have the tendency to be more than a little subjective on the investment choices we have made. Even purchases we made a decade ago, like annuities, still seem like a good idea based on the thoughts we had at the time, even if the last ten years have proven that the investment was a dud. It is hard for investors, especially those of us who are successful overall, to admit when we were wrong. And it is hard to know when is the right time to cut our losses and pull the plug on an investment vehicle. Having a reliable metric that reduces an investment package to a number makes it easier to be objective about things.
An emotionally detached evaluation will make it clear whether out investments are living up to our expectations, or whether they are really underperforming versus the market as a whole and against other investments of like type. To meet your goals as a buyer, you need to be sober and vigilant in the evaluations of the different portions of your portfolio. To make an accurate and sober assessment based on fact, the right tools are needed. The investor has to be familiar with some specific formulas and understand how to plug them in and when. The lingo of the industry should not mystify a savvy investor. Being familiar with the terminology is the key when it is time to evaluate.
As an investor, you have to remember that the only goal of investing is to make money. If your investments are not producing a strong average annual return, then they are just taking up space in your portfolio. What's more, tying up investment cash in these products prevents the investor from selecting winners to buy into. If profits are not there and annual return is weak, your investments are underperforming and significant changes are in order.
Average annual return is used to report on the historical performance of an investment. This figure takes into account expenses that have been incurred as well as reinvested dividends and distributions of capital gains. It is important to think of average annual return as an historical figure. Some investments are volatile by nature, and thus their value may jerk up and down from month to month or quarter to quarter. But over a three, five, or ten year period, if an investment is not outperforming the market and at least keeping pace with other investment vehicles of its kind, it is time to consider pulling the plug.
Again, you can't do something more positive with the money tied up in a bad fund until you cash out and get whatever principal remains. Investments that have displayed a poor average annual return should be replaced with strong historical performers. Consult with a financial advisor about ways and means for apples to apples comparisons on investments across type and industry.
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