What Is Average Return?
The average return is the simple mathematical average of a series of returns generated over a specified period of time. An average return is calculated the same way that a simple average is calculated for any set of numbers. The numbers are added together into a single sum, then the sum is divided by the count of the numbers in the set.
Key Takeaways
- The average return is the simple mathematical average of a series of returns generated over a specified period of time.
- The average return can help measure the past performance of a security or portfolio.
- The average return is not the same as an annualized return, as it ignores compounding.
- The geometric average is always lower than the average return.
Understanding Average Return
There are several return measures and ways to calculate them. For the arithmetic average return, one takes the sum of the returns and divides it by the number of return figures.
AverageReturn=NumberofReturnsSumofReturns
The average return tells an investor or analyst what the returns for a stock or security have been in the past, or what the returns of a portfolio of companies are. The average return is not the same as an annualized return, as it ignores compounding.
Average Return Example
One example of average return is the simple arithmetic mean. For instance, suppose an investment returns the following annually over a period of five full years: 10%, 15%, 10%, 0%, and 5%. To calculate the average return for the investment over this five-year period, the five annual returns are added together and then divided by 5. This produces an annual average return of 8%.
Now, let’s look at a real-life example. Shares of Walmart returned 9.1% in 2014, lost 28.6% in 2015, gained 12.8% in 2016, gained 42.9% in 2017, and lost 5.7% in 2018. The average return of Walmart over those five years is 6.1%, or 30.5% divided by 5 years.
Calculating Returns From Growth
The simple growth rate is a function of the beginning and ending values or balances. It is calculated by subtracting the ending value from the beginning value and then dividing by the beginning value. The formula is as follows:
GrowthRate=BVBV−EVwhere:BV=BeginningValueEV=EndingValue
For example, if you invest $10,000 in a company and the stock price increases from $50 to $100, then the return can be calculated by taking the difference between $100 and $50 and dividing by $50. The answer is 100%, which means you now have $20,000.
The simple average of returns is an easy calculation, but it is not very accurate. For more accurate calculations of returns, analysts and investors also frequently use the geometric mean or the money-weighted rate of return.
Average Return Alternatives
Geometric Average
When looking at average historical returns, the geometric average is a more precise calculation. The geometric mean is always lower than the average return. One benefit of using the geometric mean is that the actual amounts invested need not be known. The calculation focuses entirely on the return figures themselves and presents an apples-to-apples comparison when looking at two or more investments’ performances over more various time periods.
The geometric average return is sometimes called the time-weighted rate of return (TWR) because it eliminates the distorting effects on growth rates created by various inflows and outflows of money into an account over time.
Money-Weighted Rate of Return (MWRR)
Alternatively, the money-weighted rate of return (MWRR) incorporates the size and timing of cash flows, making it an effective measure for returns on a portfolio that has received deposits, dividend reinvestments, and/or interest payments, or has had withdrawals.
The MWRR is equivalent to the internal rate of return (IRR), where the net present value equals zero.
FAQs
For instance, suppose an investment returns the following annually over a period of five full years: 10%, 15%, 10%, 0%, and 5%. To calculate the average return for the investment over this five-year period, the five annual returns are added together and then divided by 5. This produces an annual average return of 8%.
What is an example of the average rate of return worked? ›
Calculating the average rate of return
| Option | New | Used |
|---|
| Total additional profit | £50,000 | £28,000 |
| The average rate of return for each option would be calculated as follows: | | |
| Average annual profit = | £50,000 ÷ 5 = £10,000 | £28,000 ÷ 4 = £7,000 |
| Average rate of return = | (£10,000 ÷ £40,000) × 100 = 25% | (£7,000 ÷ £25,000) × 100 = 28% |
6 more rowsThe average rate of return is the average annual amount expected from an investment. Calculating it requires dividing the anticipated annual amount of cash flow by the average capital cost. You may calculate the ARR before or after an investment to assess its financial benefits.
How do you calculate average formula? ›
Average This is the arithmetic mean, and is calculated by adding a group of numbers and then dividing by the count of those numbers. For example, the average of 2, 3, 3, 5, 7, and 10 is 30 divided by 6, which is 5.
How do I calculate my return? ›
Key Takeaways. Return on investment (ROI) is an approximate measure of an investment's profitability. ROI is calculated by subtracting the initial cost of the investment from its final value, then dividing this new number by the cost of the investment, and finally, multiplying it by 100.
How is the average rate calculated? ›
Plan The average rate is given by the change in concentration, ∆[A], divided by the change in time, ∆t. Because A is a reactant, a minus sign is used in the calculation to make the rate a positive quantity.
What is the formula used to calculate rate of return? ›
There must be two values that are known to calculate the rate of return; the current value of the investment and the original value. To calculate the rate of return subtract the original value from the current value, divide the difference by the original value, then multiply by 100.
What is a good average return? ›
A good return on investment is generally considered to be around 7% per year, based on the average historic return of the S&P 500 index, adjusted for inflation. The average return of the U.S. stock market is around 10% per year, adjusted for inflation, dating back to the late 1920s.
What is the average rate of return for dummies? ›
To calculate the average rate of return, add together the rate of return for the years of your investment, and then, divide that total number by the number of years you added together. Add together the annual rate of returns. Divide the sum by the number of annual returns you added.
What is the formula for average profit? ›
Average Profit = Total Profit / Number of Years. Estimate the Goodwill: Multiply the average profit by the anticipated number of future profits (number of years' purchase) to determine the goodwill value. Goodwill = Average Profit * Number of Years' Purchase.
The annual rate of return is the percentage change in the value of an investment. For example: If you assume you earn a 10% annual rate of return, then you are assuming that the value of your investment will increase by 10% every year.
How do you calculate average return? ›
What is the average rate of return (ARR) formula? To calculate ARR revenue as a percentage, you must take the asset's average yearly revenue and divide by initial cost. This will give you a decimal figure, which is then multiplied by 100 to create a percentage.
Which is an example of a short-term investment? ›
Examples of short-term investments include CDs, money market accounts, high-yield savings accounts, government bonds and Treasury bills. These investments are typically high-quality and highly liquid assets or investment vehicles.
Which is the riskiest investment among these? ›
The 10 Riskiest Investments
- Options. An option allows a trader to hold a leveraged position in an asset at a lower cost than buying shares of the asset. ...
- Futures. ...
- Oil and Gas Exploratory Drilling. ...
- Limited Partnerships. ...
- Penny Stocks. ...
- Alternative Investments. ...
- High-Yield Bonds. ...
- Leveraged ETFs.
Returns the average (arithmetic mean) of the arguments. For example, if the range A1:A20 contains numbers, the formula =AVERAGE(A1:A20) returns the average of those numbers.
What is the arithmetic average return formula? ›
The arithmetic return is the most basic form of average: add the numbers together and divide them by the count of numbers that were added together. The geometric return is usually more useful in finding portfolio performance, as it's the n-root of the product of n percentages.
How do you calculate the rate of return? ›
You can calculate the rate of return on your investment by comparing the difference between its current value and its initial value, and then dividing the result by its initial value. Multiplying the result of that rate of return formula by 100 will net you your rate of return as a percentage.
How to calculate average monthly return? ›
For the second calculation, the average return is the total return of the entire period (for all returns involved) divided by the number of periods. The time value of money is also accounted for here.
