What is the difference between my cumulative return and annualized return?
Suppose Mr. N. Vestor invests $100 in an investment that earns 10% this year and 10% the next year. What is his cumulative return? The answer is 21%. Here’s why. N. Vestors 10% gain makes his $100 grow to $110. Next year, he earns another 10%, leaving him with $121. His investment has earned a cumulative 21% return over two years. His annualized return, however, is 10%. The fact that the cumulative return of 21% is greater than twice the 10% annual return is due to the effect of compoundingwhich means that your yearly earnings are added to your original investment before the current years earnings are applied.
