when you are selecting a mutual fund the average annual return is a helpful guide for measuring a fund s long term performance however investors should also look at a fund s yearly performance to fully appreciate the consistency of its annual total returns 
for example a five year average annual return of 10 looks attractive however if the yearly returns those that produced the average annual return were 40 30 10 5 and 15 50 5 10 performance over the past three years warrants examination of the fund s management and investment strategy components of an average annual return aar there are three components that contribute to the average annual return aar of an equity mutual fund share price appreciation capital gains and dividends share price appreciation results from unrealized gains or losses in the underlying stocks held in a portfolio as the share price of a stock fluctuates over a year it proportionately contributes to or detracts from the aar of the fund that maintains a holding in the issue for example the american funds amcap fund s top holding is netflix nflx which represents 3 7 of the portfolio s net assets as of feb 29 2020 netflix is one of 199 equities in the amcap fund fund managers can add or subtract assets from the fund or change the proportions of each holding as needed to meet the fund s performance objectives the fund s combined assets have contributed to the portfolio s 10 year aar of 11 58 through feb 29 2020 capital gains distributions paid from a mutual fund result from the generation of income or sale of stocks from which a manager realizes a profit in a growth portfolio shareholders can opt to receive the distributions in cash or reinvest them in the fund capital gains are the realized portion of aar the distribution which reduces share price by the dollar amount paid out represents a taxable gain for shareholders a fund can have a negative aar and still make taxable distributions the wells fargo discovery fund paid a capital gain of 2 59 on dec 11 2015 despite the fund having an aar of negative 1 48 quarterly dividends paid from company earnings contribute to a mutual fund s aar and also reduce the value of a portfolio s net asset value nav like capital gains dividend income received from the portfolio can be reinvested or taken in cash large cap stock funds with positive earnings typically pay dividends to individual and institutional shareholders these quarterly distributions comprise the dividend yield component of a mutual fund s aar the t rowe price dividend growth fund has a trailing 12 month yield of 1 36 a contributing factor to the fund s three year aar of 15 65 through feb 29 2020 special considerationscalculating an average annual return is much simpler than the average annual rate of return which uses a geometric average instead of a regular mean the formula is 1 r1 x 1 r2 x 1 r3 x x 1 ri 1 n 1 where r is the annual rate of return and n is the number of years in the period the average annual return is sometimes considered less useful for giving a picture of the performance of a fund because returns compound rather than combine investors must pay attention when looking at mutual funds to compare the same types of returns for each fund 