Annualize definition
/What is Annualization?
To annualize means to extend a result to a full-year basis. In effect, it transforms a short-term result into one for an entire year. The concept is frequently used to better compare the results of different types of investments.
Annualization Best Practices
The annualization concept works best when the baseline period is already a large fraction of a year (such as nine months), since there is little remaining time over which the result can differ from historical results. Conversely, annualizing over quite a short period of time presents a risk that the results actually achieved over the remainder of the year could differ substantially from the initial annualized estimate. This is a particular problem when there is no history of results in prior years, since there is no way to tell if the results actually obtained will have a discernible trend or be seasonal. A best practice for dealing with annualizations based on a short period of time is to repeatedly return to the calculation over successive months, to see if subsequent results have altered the initial annualization.
Examples of Annualization
If a business earns $10,000 over a period of three months, the $10,000 is multiplied by four to arrive at $40,000, which is presumed to be the result that the business would achieve over four quarters.
As another example, a security earns a 4% return over a six-month period, resulting in a $1,000 return. Annualizing this result yields a full-year return of $2,000 at the same 4% rate.