What is the rate of return in finance?

The rate of return in finance is defined as the percentage increase in the value of an investment, specifically as a result of earned interest or capital gains over a specific period. It reflects the profitability of an investment relative to its initial cost and is a crucial metric for investors to assess how well their investments are performing.

Calculating the rate of return allows individuals and organizations to compare the efficiency of various investments. For example, if an investor puts $1,000 in a savings account and earns $50 in interest over a year, the rate of return would be 5% ($50 divided by $1,000). This measure provides insight into the effectiveness of different saving and investment strategies, guiding decisions about future financial actions.

The other options do not accurately define the concept of rate of return: the total amount invested merely reflects the principal, while taxes deducted from earnings relate to net profitability but do not define return. Withdrawals from an investment indicate cash flow but do not represent the rate at which the investment is earning money.