Average Annual Return (AAR)

What is an AAR?

The average annual return (AAR), which is expressed as a percentage, is the historical return that is reported for a period of time, typically the 3, 5, and ten-year average returns of a mutual fund. The average yearly return is presented net of the fund's operating expense ratio, and it also excludes sales charges, if any, and brokerage fees on portfolio transactions.

In its simplest form, AAR gauges how much money a mutual fund made or lost over a specific period. As part of their strategy for investing in mutual funds, investors considering making an investment generally assess the AAR and compare several funds that are substitutes.

AAR Explained

The average annual return is a useful metric for evaluating a mutual fund's long-term performance when choosing one. However, in order to properly comprehend the consistency of a fund's total yearly returns, investors should also consider its annual performance.

For instance, a 10% average annual return over five years seems appealing. Nevertheless, if the annual returns (those that generated the average annual return) were +50%, +40%, -20%, +15%, and -25% (60 / 5 = 12%), the fund's management and investment approach need be reviewed in the context of the last three years performance.

Components of AAR

An equity mutual fund's AAR is mainly made up of three elements, such as:

• Share Price Appreciation
• Dividends, and
• Capital Gains

Share Price Appreciation

Unrealized profits or losses in the underlying securities held in a portfolio usually cause shares to appreciate in value. The AAR of the fund that holds the issue changes proportionally as the price of stock changes over a year, either adding to or subtracting from the AAR. In order to reach the fund's performance goals, fund managers may add, remove, or modify the quantities of each investment.

Dividends

Quarterly dividend payments from firm profits typically increase a fund's AAR and decrease a portfolio's net asset value (NAV). Earned dividends from the portfolio could be reinvested or cashed off, much like capital gains.

Large-cap stock funds with profitable operations distribute dividends to individual and institutional investors. A fund's AAR's dividend yield element comprises these quarterly distributions.

Capital Gains Distribution

The creation of revenue or the selling of securities from which management makes a profit on a growing portfolio is the source of capital gains distributions given by mutual funds. Investors can receive payouts in cash or reinvest them in the fund. The realized component of AAR comprises capital gains and the distribution, which lowers the price of the stock by the amount paid out, is a taxable gain for holders.

Special Considerations

Calculating an AAR is easier than an average annual rate of return, which employs a geometric average rather than a normal mean. Since returns compound rather than combine, the AAR is frequently thought to be less effective for providing insight into a fund's performance. The same kinds of returns for each fund should be compared by investors when examining mutual funds.