Definition
The average return is a concept in finance which refers to the mean value of a series of returns generated over a period of time. It encompasses both gains and losses over the period and provides a summary of investment performance. The average return is calculated by adding up all individual yearly or monthly returns and dividing by the number of periods.
Phonetic
The phonetics of the keyword “Average Return” is /ˈævərɪdʒ rɪˈtɝːn/.
Key Takeaways
<ol><li>Average Return refers to the average percentage profit or loss an investment or asset produces over a specific period. Whether it’s stocks, bonds, funds, or any other forms of investment, the average return is often used as a tool to compare the profitability of each choice.</li><li>Calculating Average Return involves adding up all the periodic gains or losses for the asset, then dividing by the total number of periods. It’s important to keep in mind that average returns are historical and do not guarantee future results. However, they can give investors a general idea of an investment’s performance over time.</li><li>Investors should not rely solely on Average Return when making investment decisions. It does not account for the investment’s volatility or risk, nor does it consider the effects of compounding. Therefore, it’s important to also look at other performance metrics – such as Cumulative Returns and Annualized Returns, among others – for a more holistic view of the investment’s performance.</li></ol>
Importance
Average return is a critical concept in business and finance as it serves as a key indicator of the historical performance of an investment or a portfolio. It denotes the mean annual profit or loss realized on an investment over a specified period. By comparing the average returns of different investments, investors can assess their relative profitability and make informed decisions about where to allocate their funds. Moreover, average return is often used as a benchmark to evaluate the performance of investment managers, with higher average returns indicating superior management skills. Thus, it supports risk assessment, investment decision making, performance evaluations, and financial planning.
Explanation
The term “Average Return” is integral to finance and investing; it’s essentially the calculation of an investment’s gains or losses over a particular timeframe. The primary purpose of calculating the average return is to understand and evaluate the profitability of investments made. It denotes a total return over a period, divided by the number of periods, thereby producing a mean rate of return over the set interval. It allows investors to assess the historical ups and downs of an individual investment or a portfolio, and hence, serves as an important tool for forecasting future performance. In the business world, average return not only plays a significant role in measuring an investment’s past performance but also in establishing realistic expectations for its future returns. By providing a comprehensive view of an asset’s historical performance, it assists investors, portfolio managers, or other financial analysts in making informed decisions about whether to hold, buy, or sell the asset. It is an essential component in the measurement of risk and the formulation of strategies that can boost profits while mitigating losses. Consequently, the average return largely shapes the investors’ investment strategies and portfolio management plans.
Examples
1. Stock Market Investments: If you invest in the stock market, you can calculate the average return to assess the performance of your portfolio. For instance, if you invested $1000 in a stock and after a year it’s worth $1050, your annual return count is 5%. But if the next year your investment declines to $1025, your return for that year is -2.38%. The average return over these two years would be approximately (5-2.38)/2 = 1.31%.2. Mutual Funds: Mutual fund companies often advertise their average returns over certain periods. For instance, a fund may have an average return of 8% over the past 10 years. This percentage is calculated by adding up the fund’s annual returns for the past 10 years and then dividing by 10.3. Real Estate: Let’s say you buy a rental property for $100,000 and you are earning $10,000 per year in rental income. This translates to an average return of 10%. If the value of your property appreciates over time to $120,000 and your rental income increases to $12,000 per year, your average return increases to 10%. Over time, you can calculate the annual average return by considering both rental income and the appreciation of the property.
Frequently Asked Questions(FAQ)
What is Average Return?
Average Return is a measure in finance that calculates the gain or loss made on an investment relative to the amount of money invested. It’s typically expressed as a percentage and computed over a common interval, such as annually.
How is Average Return calculated?
Average Return is calculated by summing up all the returns gained from an investment, which could be in the form of dividends or capital gain, and then dividing it by the number of periods.
What is the main use of the Average Return?
The Average Return figure is used by investors to analyze and compare the historical performance of different investments or portfolios.
When should one use Average Return?
Average Return is most helpful when assessing the expected performance of a long-term investment, such as a retirement plan or an index fund.
What is the difference between Average Return and Annualized Return?
While Average Return refers to the simple average of returns, Annualized Return takes into account the compounding effect of returns over multiple periods.
Is a high Average Return always beneficial for investors?
Not necessarily. A high Average Return might be attractive, but it’s also important to assess the risk involved. A high Average Return with high volatility may be riskier than a lower Average Return with steady growth.
How can investors discover the Average Return of their investments?
Investors can usually find this information through their investment statements, financial news outlets, or public financial records of investment funds.
Does Average Return apply to both stocks and bonds?
Yes, the concept of Average Return is applied to various types of investments including stocks, bonds, real estate, mutual funds, and more. It provides a measure to gauge the relative profitability of these different types of investments.
Is Average Return a guaranteed performance indicator?
No, the Average Return is a historical or expected result. It does not guarantee any future returns or protect against loss in declining markets.
Does Average Return account for inflation?
No, the Average Return does not account for the impact of inflation. This is why some investors prefer to consider the Real Return, which subtracts the inflation rate from the Average Return.
Related Finance Terms
- Return on Investment (ROI)
- Compound Annual Growth Rate (CAGR)
- Rate of Return (ROR)
- Annualized Return
- Variance and Standard Deviation of Returns
Sources for More Information
