How to Use the Average Return Calculator
When analyzing the performance of an investment portfolio over several periods, the term "average" can be misleading if you don't know which type of average is being used. This calculator computes both the Arithmetic Average Return and the Geometric Average Return (often called Compound Annual Growth Rate, or CAGR), allowing you to accurately assess your returns.
Arithmetic vs. Geometric Mean
- Arithmetic Average: This is a simple average of the periodic returns. While it is easy to calculate, it often overstates true investment compounding, especially when there's high volatility.
- Geometric Average (CAGR): The geometric mean considers the exact compounding effect period-over-period. It represents the single, steady rate of return that would have grown the initial capital to the final capital. The geometric average is the most accurate way to evaluate long-term, multi-year investment growth.
Why Does It Matter?
If your portfolio goes up 50% one year and down 50% the next, your arithmetic average return is 0% ((50 - 50) / 2). However, if you start with $100, a 50% gain takes you to $150, and a 50% loss takes you down to $75. Your actual geometric return is negative. Utilizing true geometric calculation prevents you from being misguided by volatility.