Average Return
Candlefocus EditorThe average return should not be confused with the geometric average, which is a more precise measure of mean return. The geometric average is calculated by multiplying all the security’s or portfolio’s returns together, then taking the nth root, where n is the number of returns. The resulting figure is always lower than the average return, which may lead to discrepancies between the two metrics if the returns in the specified period were not uniformly distributed.
In most cases, the average return provides a reasonable indicator of performance when comparing assets with similar contributions to a portfolio or fund. This calculation is more effective than the geometric average when calculating the overall return on a portfolio or fund while accounting for multiple different investments with varying contribution levels.
The average return also helps evaluating the risk/return ratio of investments. By comparing the average return to the standard deviation of returns, investors can get an idea of how much risk they are exposed to for the expected rate of return on their investment.
Ultimately, average return is a valuable tool for both individual investors and financial advisors alike. It provides a simple and effective way to quickly compare different investments over a specified period, as well as to evaluate their risk/return ratio. It should be noted, however, that the average return does not factor in compounding, so it should be used in tandem with other metrics such as the geometric average and the standard deviation of returns.