What is average income?
Average return is a simple mathematical average of a series of returns obtained over a certain period of time. Average return is calculated in the same way as simple average return for any set of numbers. The numbers are added into a single sum, then the sum is divided by the number of numbers in the set.
Key Findings
- Average return is a simple mathematical average of a series of returns obtained over a certain period of time.
- Average returns can help evaluate the past performance of a security or portfolio.
- Average returns are not the same as annualized returns because they ignore compounding.
- The geometric mean is always lower than the average return.
Understanding Average Returns
There are several profitability indicators and ways to calculate them. To obtain the arithmetic average return, take the amount of income and divide it by the number of digits of return.
Average yield
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Number of returns
\text{Average return} = \dfrac{\text{Amount of returns}}{\text{Number of returns}} Average yield“=”Number of returnsRefund amount
Average returns tell an investor or analyst how a stock or security has performed in the past or how a portfolio of companies has performed. Average returns are not the same as annualized returns because they ignore compounding.
Average return example
One example of average return is the simple arithmetic average. For example, suppose an investment earns the following returns annually for five full years: 10%, 15%, 10%, 0% and 5%. To calculate the average investment return over this five-year period, the five annual returns are added and then divided by 5. The result is an average annual return of 8%.
Now let's look at a real example. Walmart shares rose 9.1% in 2014, lost 28.6% in 2015, rose 12.8% in 2016, rose 42.9% in 2017 and lost 5.7% in 2018. Walmart's average return over those five years is 6.1%, or 30.5%. divided by 5 years.
Calculation of profit from growth
The simple growth rate is a function of the initial and final values or residuals. It is calculated by subtracting the final value from the starting value and then dividing by the starting value. The formula looks like this:
Rates of growth
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Initial value
EV
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Final cost
\begin{aligned} &\text{Growth rate} = \dfrac{\text{BV} -\text{EV}}{\text{BV}}\\ &\textbf{where:}\\ &\text{ BV} = \text{Start value}\\ &\text{EV} = \text{End value}\\ \end{aligned} Rates of growth“=”BVBV−EVWhere:BV“=”Initial valueEV“=”Final cost
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 it by $50. The answer is 100%, which means you now have $20,000.
The simple average return is a simple calculation, but it is not very accurate. To more accurately calculate returns, analysts and investors also often use geometric average or money-weighted returns.
Average Return Alternatives
Geometric mean
If we consider the average historical return, then the geometric mean is a more accurate calculation. The geometric mean is always lower than the average return. One advantage of using a geometric mean is that the actual amounts invested do not need to be known. The calculation focuses entirely on the returns themselves and is an apples-to-apples comparison when looking at the performance of two or more investments over more different time periods.
Geometric mean returns are sometimes called time-weighted rates of return (TWRs) because they remove the distorting effects on growth rates created by varying inflows and outflows of money into an account over time.
Money Weighted Return (MWRR)
Alternatively, the money-weighted rate of return (MWRR) incorporates the size and timing of cash flows, making it an effective measure of the return on a portfolio in which deposits have been made, dividends and/or interest payments have been reinvested, or withdrawals have been made.
MWRR is equivalent to the internal rate of return (IRR), where the net present value is zero.
