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
Average Return Example
How is average return calculated? ›
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 rate of return? ›
Divide the average annual profit by the investment or asset's initial cost. Multiply the resulting decimal figure by 100 to see ARR in a percentage format.
What is the formula for the average real return? ›
The real rate of return is the actual annual rate of return after taking into consideration the factors that affect the rate like inflation and it is calculated by one plus nominal rate divided by one plus inflation rate minus one and inflation rate can be taken from consumer price index or GDP deflator.
What is the formula for average daily return? ›
Calculation of Average Daily Returns
To calculate daily returns, subtract the closing price of an asset on one day from its closing price on the previous day, then divide the result by the closing price of the previous day. This calculation gives the daily percentage change in the value of the investment.
What is the correct formula for calculating return? ›
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 to calculate average? ›
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 you calculate return rate? ›
Calculating your return rate
To calculate your return rate, divide the number of units returned by the number of units sold, multiplying the product by 100 to find your percentage. For example, if you sold 100 widgets, and 10 widgets were returned, you would divide 10 by 100, which equals 0.1.
What is a good average return rate? ›
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.
How to calculate expected return? ›
The expected return is calculated by multiplying the probability of each possible return scenario by its corresponding value and then adding up the products. The expected return metric – often denoted as “E(R)” – considers the potential return on an individual security or portfolio and the likelihood of each outcome.
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.
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.
How do you calculate return on average? ›
For the arithmetic average return, one takes the sum of the returns and divides it by the number of return figures. 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.
What does the average formula return? ›
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.
How do you calculate average rate or return? ›
The average rate of return (ARR) is the average annual return (profit) from an investment. The ARR is calculated by dividing the average annual profit by the cost of investment and multiplying by 100 percent. The higher the value of the average rate of return, the greater the return on the investment.
How the average accounting return is usually calculated? ›
The accounting rate of return (ARR) formula is helpful in determining the annual percentage rate of return of a project. ARR is calculated as average annual profit / initial investment.
How do you calculate average accounting return? ›
The Accounting Rate of Return formula is as follows: ARR = average annual profit / average investment.
