Average return

Definition

Average return refers to the mean rate of gain or loss on an investment over a specified period of time. It is a statistical measure used in finance to assess the performance of an investment or a portfolio. 

What is the average return?

The average return is calculated using the following formula: 

Average return = ∑(Returns for each period) / number of periods

It provides a single figure representing the typical return for a given investment.

The time period used for calculating average return is crucial. It could be daily, monthly, annually, or any other relevant time frame depending on the nature of the investment.

The average return does not provide information about the risk or volatility of an investment. Two investments with the same average return may have significantly different levels of risk.

While average return provides a useful summary of historical performance, it does not indicate the sequence or timing of returns. Additionally, it does not account for compounding, which can significantly impact overall investment results. To get a more comprehensive view of investment performance, average return is often used in conjunction with other metrics.

It’s important to note that past average return is not necessarily indicative of future performance. Various external factors, market conditions, and economic events can significantly impact future returns.

Example of average return

1. Investment performance:
   • Suppose an investor has invested in a stock over a period of five years. The annual returns for each year are as follows: 8%, 12%, -5%, 15%, and 10%.
2. Calculation of average return:
   • To calculate the average return, sum up the individual annual returns and divide by the number of years.
     Average Return = (8% + 12% − 5% + 15% + 10%) / 5​
     Average Return = 40% / 5 = 8%

   The average return for the investment over the five-year period is 8%