Primary navigation:

QFINANCE Quick Links
QFINANCE Reference

Home > QFINANCE Dictionary > Definition of rate of return

Definition of

rate of return


ratio of investment profit to investment cost an accounting ratio of the income from an investment to the amount of the investment, used to measure financial performance.

There is a basic formula that will serve most needs, at least initially:

[(Current value of amount invested − Original value of amount invested) / Original value of amount invested] × 100% = Rate of return

If $1,000 in capital is invested in stock, and one year later the investment yields $1,100, the rate of return of the investment is calculated like this:

[(1,100 − 1,000) / 1,000] × 100% = 100 / 1,000 × 100% = 10%

Now, assume $1,000 is invested again. One year later, the investment grows to $2,000 in value, but after another year the value of the investment falls to $1,200. The rate of return after the first year is:

[(2,000 − 1,000) / 1,000] × 100% = 100%

The rate of return after the second year is:

[(1,200 − 2,000) / 2,000] × 100% = −40%

The average annual return for the two years (also known as average annual arithmetic return) can be calculated using this formula:

(Rate of return for year 1 + Rate of return for year 2) / 2 = Average annual return


(100% + −40%) / 2 = 30%

The average annual rate of return is a percentage, but one that is accurate over only a short period, so this method should be used accordingly.

The geometric or compound rate of return is a better yardstick for measuring investments over the long term, and takes into account the effects of compounding. This formula is more complex and technical.

The real rate of return is the annual return realized on an investment, adjusted for changes in the price due to inflation. If 10% is earned on an investment but inflation is 2%, then the real rate of return is actually 8%.

Related definitions of "rate of return"

Recommended Further Reading (Term count)
  • Valuing Pension Fund Liabilities on the Balance Sheet
    by Steven Lowe
    With a pension plan, companies agree to provide certain benefits to their employees, by specifying either a defined contribution (where a fixed contribution is made to the plan each year by the employer, with no promises as to the future benefits that will be delivered by the plan) or a defined benefit (where the employer undertakes to pay a certain benefit to the employee at some point in the future). Under the latter, the employer has to put...
  • The Financial Crisis and the World’s Poor
    by Muhammad Yunus
    Professor Muhammad Yunus is the founder and Managing Director of Grameen Bank which provides micro-credit to millions of poor people in Bangladesh. In 2006 he was awarded the Nobel Peace Prize.Yunus pioneered microcredit, the innovative banking program that provides the poor—mainly women—with small loans they use to launch businesses and lift their families out of poverty. Yunus’s vision is the total eradication of poverty from the world. This...
  • Understanding Equity Capital in Small and Medium-Sized Enterprises
    by Siri Terjesen
    Entrepreneurs may require both debt and equity financing, and often start their firms by financing growth through equity. Equity capital is money invested in the venture with no legal obligation on the entrepreneur to repay the principal amount or to pay interest on it; however, it requires sharing the ownership and profits with the funding source, and possibly also paying dividends to equity investors.After value has been built, entrepreneurs...
  • Discounted Cash Flow
    Discounted cash flow (DCF) is a way of measuring the net present value (NPV) of future cash flow. This allows companies to express the value of an investment today based on predicted future returns. The idea behind discounted cash flow is that $1 today is worth more than $1 you might receive in the future. The money you have now can be invested and might generate interest whereas money you haven’t yet received can’t be used in this way, and...

Definitions of ’rate of return’ and meaning of ’rate of return’ are from the book publication, QFINANCE – The Ultimate Resource, © 2009 Bloomsbury Information Ltd. Find definitions for ’rate of return’ and other financial terms with our online QFINANCE Financial Dictionary.

Back to top