How to calculate annualized return

Annualized Return

Compare 2 investments tools of compound interest, or Fixed Deposit for easier understanding:
(A) 3 years return 30%
(B) 10 years return 120%

Which one is more profitable?

If you think 30%/3 = 10% and 120%/10 = 12% so, (B) is better. Then you are wrong. This is because time value of money. The return of every year is different, so, you cannot "average" it by year. You need "Annualized" them.

2 formulas can be used:
(1) (1+return%)^(1/no of years)-1
(2) (ending value / start value)^(1/no of years)-1

Back to the case above, (1+30%)^(1/3)-1=9.14%, (1+120%)^(1/10)=8.2%.
Conclusion: (A) is more profitable.

So, if anybody ask you invest 100k and can get 180k (80% return) in 20 years, you can ask he back, "are you happy with 2.98% return every year?"

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