Can you help me understand the idea of "annualized returns"?

Question

If a person makes a one time 6% return in January, the annualized return is 6x12=72%. I don't understand the point of calculating an annualized return, if the actual return was a one time incident. I see annualized returns being mentioned with regards to arbitrage and other events.

What is the significance of calculating an annualized return of something one time?

Answer 1

Annualizing the returns on investments allow you to compare investments of different durations (time periods).

For example your example of a 6% return in one month is equivalent to an investment that returns 72% annually (if you do not have compounding). This assumes that you could make that same investment each month and get 6% each month. At the end of the year you would have made 72%.

Suppose you invested $10,000 and got a return of $600 or 6% at the end of one month. Assuming you can make that same $10,000 investment each month, and get 6% each month, then its the same as investing $10,000 for 1 year and getting 72%.

If the 6% is a onetime deal then it's sort of meaningless to annualize it. But it is still better than a 6% annual return since you have 11 months left to invest the $10,600 and get more return on your investments.

These number may sound very HIGH (72%) but some low margin retail investments can get you these kind of returns. IF you can purshase goods and get a 6% return (profit margin) on them and also sell the inventory within 1 month. You would have essentially found a 72% annualized investment (actually higher assuming you can reinvest the gains and get counpounded interest) because of the turnover of inventory of 12x.

Answer 2

it is just 4 simplification & coparision

all returns r in annual