Categories

Investing

Tools

  • Economy & Politics
  • Investing
  • Personal Finance
  • Related Posts


    Growing Up Poor Affects Adults’ Sense Of Control, Impulsiveness When Faced With Economic Uncertainty
    China Becoming Global Gold Hub And Gold Price Discovery Center
    China Bond Default Risk Reignites, Despite “Never Anticipating Any Risks”
    Gold’s Sudden Ignorance Of Geopolitical Risk
    Why So Much Anger In Ferguson? 10 Facts About The Massive Economic Gap Between White & Black America
    Jack Lew’s Worst Nightmare: China’s Currency Should Be 20 Percent ‘Weaker’
    Fed Fueled M&A Destroys Capital
    Market Snapshot: U.S. Stocks: S&P, Dow Edge Lower Pre-Fed Minutes; Target Drops
    Americans Pay Too Much For Bad Data Plans
    U.S. Mortgage Applications Rise In Latest Week
    Staples Says Weakness In Core Office Supplies Hurting Sales
    Home Improvement Chain Lowe’s Cos Cuts Sales Forecast
    Citigroup Seeks To Exit Japanese Retail Banking
    Global Stocks Halt Rally, BoE Jolts UK Markets
    China Fines Japanese Auto Parts Makers Record $201 Million For Price-fixing


    The Right Way to View ‘Annualized Gain’ Claims

    Who wouldn’t like to claim a 423,181 percent return in one day?

    Earlier this year, one of my analysts logged a trade with an annualized gain of 423,181 percent. (That’s not a typo.)

    Of course, he’s no billionaire just because of that trade.

    But his trade raises a question people often have about “annualized gains.”

    I frequently get questions on how people should view annualized returns. They can be badly misused and badly misunderstood. So why would an investor even care about them? I’ll explain below why you should care about them.

    In simplest terms, annualized return calculates what would happen if you repeated a trade’s success over the course of a year. If you close a trade for a 10 percent gain over six months, you have a 20 percent annualized gain. The trading year is made up of two six-month periods. And two times a 10 percent nominal return equals a 20 percent annualized return.

    This math makes sense. It lets us compare the success of various trades over various time frames. For example, if you make 50 percent on a trade in just two months, it’s better than making the same gain in two years.

    But extreme “annualized return” examples can create absurd numbers and expectations.

    Take a trader who buys a stock and sells it the next day for a 1 percent gain. That expert can claim an annualized gain of 252 percent. (The convention is to assume there are 252 trading days each year.)

    And if you factor in the effect of compounding gains, the numbers get even bigger. Compounding returns refers to when one day’s gains are reinvested the next day, increasing the value of each subsequent day’s gain. If you calculate compounding returns, the trader can claim an annualized return of 1,127 percent.

    A similar distortion resulted in my analyst’s eye-popping return: He recently closed a trade for a 114.29 percent gain in 23 days. Accounting for compounding returns, he can legitimately claim a six-figure annualized rate of return.

    I think you can quickly tell this is unrealistic and probably impossible. Annualized gains may look good. But they don’t put any money in your pocket. You can’t buy anything with them.

    Also remember, since you can’t lose more than 100 percent on most investments, a 1 percent loss in a single day comes out to an annualized loss of 92 percent. (If you shave 1 percent off the value of something every day, you’ll never reach zero. You simply end up cutting smaller and smaller pieces off a smaller and smaller pie.)

    Compare that with the annualized gain of 1,127 percent, and you can see how adding up a bunch of annualized gains can quickly distort the truth.

    If that’s the case, why use “annualized gains” at all?

    Because annualized returns are a key tool for comparing the returns of investments with different timeframes.

    Suppose I offer you the choice of two investments.

    Investment A will return 4 percent in three months. Investment B will return 7 percent in five months. It’s clear that Investment B offers a higher return, but it will take longer to get it.

    This is where using annualized gains can help. Investment A has an annualized return of 16.99 percent. Investment B has an annualized return of 17.63 percent. Investment B still offers the better return.

    So what are the rules to annualized gains?

    First, don’t take them as gospel if someone is trying to convince you of an investment or trading strategy. Second, the shorter the time period, the less useful annualized gains get. (Think about the one-day trade example.)

    Again, to calculate your own annualized gains, you just need to do a little bit of simple math. Start with how long the trade will last (or lasted). Then, figure out how many of those time periods fit in a year. Finally, multiply the result by the gains.

    So let’s say you have a trade that will close in three months. There are four three-month periods in a year. If the trade returns 10 percent, your annualized return is 40 percent (four times 10 percent).

    Of course, as the saying goes, you can’t “eat” annualized returns. And you should always be skeptical if an annualized gain sounds outlandish.

    But don’t dismiss them entirely. They’re a handy tool for comparing different trades.

    Here’s to our health, wealth and a great retirement,

    — Dr. David Eifrig

    This article originally ran on Wednesday, Aug. 14, at DailyWealth.com.

    Dr. David Eifrig Jr. is the editor of two of Stansberry's best advisory services. One of his advisories, Retirement Millionaire, is a monthly letter showing readers how to live a millionaire lifestyle on less than you'd imagine possible. He travels around the U.S. looking for bargains, deals and great investment ideas. Already his average reader has saved $2,793 since 2008 (documented in each Retirement Millionaire issue). He also writes Retirement Trader, a bi-monthly advisory that explains simple techniques to make large, but very safe, gains in the stock and bond markets. This is a pure finance play and the reason Porter Stansberry loves having "Doc" on the team. Doc holds an MBA from Kellogg and has worked in arbitrage and trading groups with major Wall Street investment banks (Goldman Sachs). In 1995, he retired from the "Street," went to UNC-Chapel Hill for medical school and became an ophthalmologist. Now, in his latest "retirement," he joined Stansberry & Associates full-time to share with readers his experiences and ideas.

    | All posts from Dr. David Eifrig Jr.

    Discuss this Story:

    Comment Policy: We encourage open discussion. Comments including racist statements, profanity, name calling or spam will be removed at our discretion. We use filters for spam protection. If your comment does not appear it is likely because it violates the policy.

    Amid Investor Pressure, PetSmart Says To Explore Sale
    ISIS Gets Angrier At America: ‘We Will Drown All Of You In Blood’
    Housing Permits, Starts Surge Driven By Renewed Rental Housing Scramble
    A Brief History Of US Money
    Starting This Year, Minorities Will Outnumber Whites In U.S. Public Schools
    Is Your Airline Poisoning You?
    What To Look For In Dueling Autopsies Of Michael Brown
    How To Profit From The World’s “Scariest” Stock Exchange
    Biogen Idec Gains On FDA Approval Of New MS Drug
    Silver Price Forecast This Week: Downside Speculation Mounting
    Why Investing In Solar Energy Is Attracting The Big Boys
    Strong Spring Sales Help Home Depot Beat Estimates
    BHP Unveils Spin-off But Disappoints With No Buyback
    Futures Higher After Home Depot Results, Data On Tap
    Stocks Head Higher As Risk Appetite Returns
    Heinz To Tighten Supplier Controls In China After Infant Food Scare
    Dollar General Enters Race For Family Dollar With $8.95 Billion Bid
    Inflows To Hong Kong ETFs Soar As Foreigners Bet On Chinese Stocks
    Sprint Cuts Rates, CEO Says More New Plans To Come
    Why Tesla Stock Will Double In The Next 12 Months
    All Eyes On Jackson Hole: Key Events In The Coming Week
    Risk On After Ukraine’s “Convoy Shelling” Hoax Forgotten
    Passport’s John Burbank: “The Next Crisis May Look Like A 1987 Crash”
    If Not Trusting This Market Makes Me An Idiot, Then Call Me Crazy!
    Control The Language And You Control The Mind
    Ferguson Is Not Binary
    Red Cross Reverses Stance on Sandy Spending “Trade Secrets”
    Europe Shares Rally As Ukraine Fears Ease, Oil Drops
    China Finds Mercedes-Benz Guilty Of Price Fixing
    Dollar General Counters Dollar Tree Bid For Family Dollar
    Read more from Investing...

    Liberty Investor Digest

    Get today's most important
    financial headlines all in
    one place by email!



    Sources


    close[X]

    Sign Up For Liberty Investor Digest™!

    Get Liberty Investor Digest FREE By Email!

    Input your name and email address in the fields below and get today's most important financial headlines sent straight to you inbox!

    Privacy PolicyYou can opt-out at any time. We protect your information like a mother hen. We will not sell or rent your email address to anyone for any reason.