| To understand how to calculate the rate of return on your investments, please follow this investment scenario. Let's say you invest $10,000 in stock, which is called your capital. One year later, your investment yields $11,0000. What is the rate of return of your investment? We calculate it by using the following formula: ((Return - Capital) / Capital) × 100% = Rate of Return Therefore, (($11000 - $10000) / $10000) × 100% = 10% Your rate of return is 10%.
There are two ways to measure the rate of return on an investment. A simple example below will show what these two yardsticks measure. 
You initially invest $10,000. One year later, your investment grows to $20,000 in value. The year after that, the investment drops back to $10,000. The rate of return after the first year is ((Return - Capital) / Capital) × 100% = Rate of Return (($20000 - $10000) / $10000) × 100% = 100% The rate of return after the second year is (($10000 - $20000) / $20000) × 100% = -50% By using the formulas for calculating the average annual rate of return, we get a percentage that measures gains accurately over only a short period. Whereas, the geometric or compound rate of return is a better yardstick to measure your investment over the long run. The arithmetic mean or average return should be used to calculate return on investment only in the short-term.
Note : Mutual fund managers report the average annual rate of return (arithmetic) on the investments they manage. As shown in the above example, the arithmetic return of the investment is 25%, even though the value of the investment is the same as it was two years ago. Thus, mutual fund reports are somewhat deceptive.
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