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 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.
What is an example of the average rate of return worked? ›
Show answer
| Total additional profit | £72,000 | £135,000 |
|---|
| Average annual profit = | £72,000 ÷ 3 = £24,000 | £135,000 ÷ 3 = £45,000 |
| Average rate of return = | (£24,000 ÷ £150,000) × 100 = 16% | (£45,000 ÷ £375,000) × 100 = 12% |
What is an Average Return? Average return is the mathematical average of a sequence of returns that have accrued over time. In its simplest terms, average return is the total return over a time period divided by the number of periods.
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.
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 interpret the average rate of 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 is return rate calculated? ›
A return rate compares the number of units returned against the number of units sold. 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.
How do you calculate rate of return simple? ›
Calculate Simple Rate of Return
Take your annual net income and divide it by the initial cost of the investment. In this case, a $37,000 net operating income divided by $200,000 leaves you with a simple rate of return of 18.5 percent.
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 average return in accounting? ›
The average accounting return (AAR) is the average project earnings after taxes and depreciation, divided by the average book value of the investment during its life. Approach to making capital budgeting decisions involves the average accounting return (AAR).
How do you calculate the average return? ›
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 difference between average return and actual return? ›
An average rate of return can mask losses over time, so what investors really want to keep an eye on is the actual rate of return. If an investment adviser touts an impressive average rate of return, be very wary, because losses can “hide” among the gains and hinder your financial success.
How to calculate actual 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.
Why do we calculate average rate of return? ›
The average rate of return is a way of comparing the profitability of different choices over the expected life of an investment. To do this, it compares the average annual profit of an investment with the initial cost of the investment.
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 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 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.
