What is Rate of Return?

Published by Thomas Herold in Accounting, Economics, Investments

'Rate of Return' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

In the worlds of finance and business, the rate of return, also known by its acronym ROR, proves to be the ratio of money lost or gained pertaining to an investment and the sum of money that is originally invested in it. This rate of return is also called the rate of profit or more commonly the return on investment, or ROI.

The sum of money that is lost or gained could be called the loss or profit, interest, or even net loss or net income. Regarding the money that is actually invested, it is sometimes called the capital, asset, or principle. It is also referred to as the cost basis of an investment. Rate of return or Return on Investment is commonly stated as a percentage and not a fraction.

This rate of return is one measurement of how much cash is made or lost as a direct result of the investment in question. It quantifies the amount of income stream or cash flow that moves from the investment itself to the investor as a percentage of the original amount that the investor put into the investment. Such cash flow that accrues to the investor comes in a number of forms. It might be interest, profit, capital gains and losses, or dividends received. These capital gains and losses happen as the investment’s sale price is greater or less than its initial purchase price. The use of the term cash flow includes everything except for the return of the original invested money.

Rates of return can be figured up as averages covering a number of different time periods. They may also be determined for only one time frame. When these calculations are being made, it is important not to mix up annualized and annual rates of return. Annualized rates of return prove to be geometric average returns figured up over several or even numerous periods. Annualized returns might be the investment return on a period less than or greater than a year, for example for six months or three years. The rates of return are then multiplied out or divided in order to come up with a one year rate of return that can be compared against other annual rates of return. As an example, if an investment possessed a one percent rate of return per month, then this might be more appropriately expressed as an annualized rate of return of twelve percent. Or, if you had a three year rate of return amounting to fifteen percent, then you could say that this is a five percent annualized rate of return.

Annual rates of return are instead returns figured up for single time frame periods. These time frames are commonly one year periods running from the first of January to the last day of December. Alternatively, they could cover any year long period, regardless of what month and day they started and ended.

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The term 'Rate of Return' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.