Rate of return: Understanding your investment
You work hard for your money—but is your money working hard for you? Whether it's gaining interest in a savings account or riding the ups and downs of the stock market, one number tells the story: your rate of return.
Rate of return (RoR) is like a report card for your investments. It shows how much you've gained—or lost—over time. It's a key number that every investor, saver or homeowner should understand.
So, let's break down what RoR really means, including how to calculate it, the different types you might encounter, and how it compares to other investment performance metrics.
What is rate of return?
Rate of return tells you the percentage gain or loss on an investment over a certain period of time. That last part is critical because it tells you how long it took for that gain or loss to occur.
For example, if you invest $1,000 and it grows to $1,200, you've gained $200—a 20% RoR. But did the investment take a year, five years or 10 years to earn that $200? Obviously, the answer changes your perception of the investment's performance.
To make sure you're making an apples-to-apples comparison when looking at the past returns of various investments, annualized RoR—or the average rate of return per year—is often more helpful than the Total RoR.
RoR applies to many types of investments, including:
- Stocks and bonds
- Mutual funds and exchange-traded funds (ETFs)
- Guaranteed Investment Certificates (GICs)
- Savings accounts
- Real estate
- Gold or other precious metals
How to calculate rate of return
This is the basic formula:
Simple Rate of Return
RoR = [(Final Value – Initial Value) / Initial Value] × 100
Let's plug in the numbers using our example above:
- You bought stocks for $1,000
- One year later, they're worth $1,200
RoR = [(1,200 – 1,000) / 1,000] × 100
= (200 / 1,000) x 100
= 0.2 x 100
= 20%
Your investment grew by 20% over one year.
Pro tip: Always include the time period when discussing RoR. A 10% return over one year is much more impressive than 10% over five.
Not a math whiz? Use an online calculator to crunch the numbers easily.
Beyond simple rate of return
While the RoR formula above works for simple investments, such as a GIC or one-time purchase of a growth stock, there are a number of factors this basic calculation may not account for.
For example, when an equity pays you dividend income, that additional return on your investment won't show up in the stock's price. And if you have a portfolio of investments that you contribute to or draw from regularly, simple RoR won't account for the size or timing of those cash flows. The impact of taxes or inflation on your RoR is another piece to factor in.
That's why, when it comes to RoR, it's important to understand what exactly you're measuring, how to measure it, whether to include inflation, and how to standardize it to compare with other investments. Here are the questions you need to ask yourself, and how to get the right answers.
1. What am I measuring?
There are two ways to measure RoR:
- Price return shows the change in price or market value of an investment only. It doesn't include any income on the investment, such as dividend payments or other distributions.
- Total return is more inclusive, as it's a combined measure of both the change in an investment's market value and any income it generates.
This is an important distinction. For example, say you invest $10,000 in a stock that grows in value by $600 and pays $400 in dividends in one year. The price return is 6% for the year, but the total annual return is 10%.
In fact, many investors make the mistake of simply comparing the current price to the purchase price, while ignoring all the dividends/distributions received and wondering why their return is so low. The real problem is that they are measuring price return instead of total return.
Pro tip: You might also sometimes see the term "dividend yield," which shows investors the rate of dividend income they're earning from an investment, relative to its price. For example, a stock priced at $50 that pays $2/year in dividends has a 4% yield. This is meant to help you better evaluate what your total return on an investment might be.
2. How do I calculate it?
Beyond the informal method above, there are two more detailed ways to calculate RoR:
- Time-weighted RoR looks at the performance of an investment during a specific period, without considering the size or timing of contributions or withdrawals during the period. This calculation is often used to convey a mutual fund's or ETF's RoR in its "fund facts" document, since cash flow doesn't factor in.
- Money-weighted RoR, also called internal rate of return (IRR), accounts for the size and timing of cash flows. This is a more accurate way to measure the performance of more complicated investments, such as the personal portfolio of an investor who regularly adds or withdraws funds. The formula to calculate IRR is fairly complicated, since it must measure RoR for every interval in which cash flowed in or out. There are special calculators or spreadsheets that will calculate IRR for you. 👉 Note: This is the method that Tangerine uses when displaying our Investment Clients' rate of return. Unlike the basic formula for Rate of Return, IRR takes into account any deposits/contributions or withdrawals over time. For instance, Tangerine allows Clients to make regular automatic investments to their Portfolios. The IRR calculation accurately reflects the impact of these ongoing contributions.
3. Do I account for inflation?
Real Rate of Return
Real RoR = Nominal Rate - Inflation Rate
You can express RoR on investments in the following two ways:
- Nominal rate of return
This is the raw RoR on your investment, before accounting for inflation. Nominal RoR is often a helpful metric when tracking the performance of an investment or portfolio over time.
Example: You buy $1,000 of a company's stock and sell it for $1,100 a year later. Your annual nominal RoR is 10%—but that's before you adjust for inflation.
- Real rate of return
Real RoR, on the other hand, takes inflation into account. So it's a truer measure when you're trying to anticipate the effect investment gains or losses will have on your wealth in the future.
Example: You buy a one-year TFSA GIC with a 3.25% nominal RoR. In this case, the annual inflation rate is 1.75%, which reduces how much your money (and gains) are worth. So, your real RoR—or the percentage growth in real-world purchasing terms—is 1.5%.
4. How can I compare with other investments?
The answer is to use annualized rate of return. Also known as compound annual growth rate (CAGR), this metric smooths out the RoR across multiple years to show the average yearly growth, assuming compounding (meaning the full investment amount and earnings are reinvested each year).
Annualized Rate of Return
Annualized RoR = [(Final Value / Initial Value) 1 / Years – 1] x 100
Example: You invest $5,000 in a volatile stock, and at the end of three years, it's worth $7,000. However, as the chart below shows, the year-to-year RoR was anything but steady. Calculating the annualized RoR at the end of the three years gives you a better sense of the stock's average yearly performance.
Annualized RoR can make it easier to compare two different investments. It's also useful for long-term comparisons, especially when returns vary year to year.
Annualized RoR = [(7,000 / 5,000) 1/3 – 1] x 100
= (1.4 1/3 – 1) x 100
= (1.11869 – 1) x 100
= 0.11869 x 100
= 11.9%
The annualized RoR is 11.9%
Value |
RoR for the year |
Cumulative RoR |
Annualized RoR |
|
|---|---|---|---|---|
Initial investment |
$5,000 |
-- |
-- |
-- |
Value after year 1 |
$6,000 |
20% |
20% |
20% |
Value after year 2 |
$5,340 |
-11% |
6.8% |
3.3% |
For illustrative purposes only
What is a good rate of return?
The honest answer? It depends. What makes a "good" RoR is shaped by your risk tolerance, time horizon, financial goals and even the type of account you're using.
If you're saving for a short-term goal, like a vacation or emergency fund, a modest return from a high-interest savings account or GIC may be perfectly fine. The priority in that case is safety and accessibility, not maximizing growth.
On the other hand, if you're investing for retirement decades down the road, you might be more comfortable with the ups and downs of the stock market in exchange for higher long-term returns. [For example, for the 50-year period ending Dec. 31, 2024, the Canadian stock market (measured by the S&P/TSX Composite Index) had an average annual return of about 10%, while U.S. stocks (measured by the S&P 500) have averaged about 13%.]
Taxes also matter. The same investment can deliver a different after-tax return depending on whether it's held in a registered account like a TFSA or RRSP, or in a taxable account. For example, a 7% return in a TFSA stays 7% in your pocket, while the same return in a non-registered account could be impacted by taxes.
Diversification—spreading your investments across asset types—can help manage risk while aiming for reasonable returns.*
Know your numbers, plan for a healthy financial future
Given that RoR is often marketed to investors, understanding how it's calculated and knowing how to scrutinize the numbers empowers you to make better financial decisions by being better informed. It helps you:
- Track how well your investments are performing
- Set realistic expectations
- Make smarter comparisons across investment types
- Spot hidden costs that eat into your growth
Even small improvements in RoR—by cutting fees or reinvesting dividends—can add up significantly over time. So don't leave your returns to chance.
Explore Tangerine's tools and Investment Funds to start tracking your returns.
*Diversification does not guarantee a profit or eliminate the risk of loss
