What is the Average Annual Return (AAR)?
How Does the Average Annual Return (AAR) Work?
The formula for AAR is:
AAR = (Return in Period A + Return in Period B + Return in Period C + ...Return in Period X) / Number of Periods
Let's look at an example. Assume that Mutual Fund XYZ records the following annual returns:
Using this information and the formula above, we can calculate the AAR for the period from 2000 to 2003: AAR = (20% + 25% + 22% + 1%) / 4 = 17%
Why Does the Average Annual Return (AAR) Matter?
AAR is somewhat useful for determining trends. However, because returns compound (they generally not add) AAR is typically not regarded as a correct form of return measurement and thus it is not a common formula for analysis.
In addition, one or a few particularly high or low data points ('outliers') can skew the average and provide misleading results. Thus, most analysts prefer to use the compound annual growth rate (CAGR) when evaluating changing returns.