By calculating the compound annual return you earned over different lengths of time, you can determine your portfolio performance.
If you own mutual funds, you’re probably familiar with returns calculated for different periods. Mutual funds typically publish their returns [Hack #63] for the most recent one-year, three-year, five-year, and ten-year compound annual returns, and will publish their compound annual return since the inception of the fund if it has existed for longer than ten years. For mutual funds, the long-term returns are more important, because funds can run hot and cold in shorter periods. Individual investors and investment clubs can also use compound annual return calculations to see how they’re doing. However, you must understand internal rate of return calculations to evaluate your performance in a meaningful way.
For mutual funds or your portfolio, long-term performance is usually more revealing than short-term returns. Long-term results can indicate how well an investment or portfolio performs through good times and bad. Although long-term performance still does not guarantee future results, you can forecast similar returns for the future with more confidence. On the other hand, short-term performance can be misleading, and the distortion increases as the timeframe shortens.
The compound annual returns you want to calculate are also known as the ...