Arithmetic average return

Definition

Arithmetic average return is the sum of a series of returns divided by the number of observations in the series. It provides a simple average that indicates the typical return over a given period.

5 Must Know Facts For Your Next Test

1. Arithmetic average return does not account for compounding effects over time.
2. It is useful for understanding the central tendency of historical returns.
3. The formula is (Return1 + Return2 + ... + ReturnN) / N, where N is the number of periods.
4. This measure can be misleading if returns are highly volatile or span multiple periods with significant variation.
5. It is often contrasted with geometric average return, which adjusts for compounding.

Review Questions

• What is the main limitation of using arithmetic average return for forecasting future performance?
• How do you calculate the arithmetic average return for a set of annual returns?
• Why might an investor prefer geometric average return over arithmetic average return?

Related terms

Geometric Average Return: The compounded annual growth rate over a specified period, accounting for compounding effects.

Volatility: A statistical measure that represents the degree of variation or dispersion of returns.

Risk-Adjusted Return: A concept that measures investment returns relative to the risk taken to achieve those returns.