Annualized return is the average amount of money earned from the investment on a yearly basis over a given period of time. The term annualized means the conversion of a rate regardless length into a rate that reflects the return on an annual basis. It is only a snapshot of the performance of the investment and do not indicate the volatility to the investors. Annualized return, simply provides a geometric average, rather than arithmetic average.
When an investor makes an investment, money is invested in different assets and earns returns over different time periods. For instance, there is a 3 month investment in Treasury Bills, and investors may also invest in stock and exist after a short time. Now, the investor may compare the returns of the amount invested in different stocks with different length of time.
A mutual fund could earn returns varying from 3% to 5% annually and have annualized return of 4%. However, the fund could also be more volatile, losing 3% in 1st year, earning 12% in 2nd year, showing the annualized total return of 4.5%. The reason for the difference is that the first fund would give you steady returns, while second fund would offer usually fluctuating returns. That is why, annualized return has one limitation. If the money will be re-invested and get a return of 5% quarterly, then there will be no surety of getting the same returns over the next remaining quarters in the year.