Definition of AAR

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Financial Definition of AAR

What It Is

The average annual return (AAR) is the arithmetic mean of a series of rates of return.

How It Works

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:

Year    Return
2000    20%
2001    25%
2002    22%
2003    1%

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 It Matters

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.

Source: Investing Answers

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