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Rate of return

Rate of return is a synonym for yield. It usually refers to an annual percentage yield on an investment.

Expanded Definition

The rate of return is what an investment pays back, usually on an annual basis.

However, there are a couple of specialized uses of this phrase.

Expected rate of return

In calculating an intrinsic value of a company through valuation models such as the dividend discount model or discounted cash flow model, one of the terms required is the "discount rate." This is the rate used to convert future dollars back into present dollars, arising out of the time value of money.

The discount rate is also the rate of return expected by the investor. If you buy stock of Nike with the expectation of earning an average of 10% per year, than that is your expected rate of return as well as the discount rate you would apply when calculating an intrinsic value of Nike.

Internal rate of return

This is the rate of return a portfolio earns per year, taking into account the growth (or not) of value of the holdings of the portfolio, as well as any cash paid in or withdrawn from the portfolio by the portfolio owner (which does not include dividends). It can either be dollar-weighted, which accounts for the timing of cash flows in and out, or time-weighted, which gives a measure of the actual performance of the underlying investments.

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