Understanding Average Return
An average return represents the total return over a specific period divided by the number of periods.
It is calculated using the same method as a simple mean.
Average return is commonly used to assess the average growth rate of an investment over time, allowing for an analysis of its value increase or decrease.
Utilizing Average Return
Investors and market analysts often employ the average return to evaluate an asset’s past performance and assess the financial health of a project before making investment decisions.
It is also used to determine the overall returns of a company’s portfolio.
Limitations of Average Return
While the average return is a straightforward calculation, it may not provide the most accurate representation.
One limitation is that it ignores the effect of compounding, making it less popular among investors.
As an alternative, investors and analysts prefer using money-weighted returns when calculating rates of return.
Another accurate measure is the geometric average, which is considered inferior to the average return due to the need to consider the exact sums involved.