Risk and Return Measures - Measures of Investment Return


  1. Geometric Average/Arithmetic Average - These are both measures of central tendency.
    1. Geometric Average: the average compounded return. The formula is expressed as follows:
Formula

GM=n((1.R1)(1+R2)...(1+Rn)-1
    1. Arithmetic Average
: division of the sum of the returns for each period by the number of periods under evaluation. The formula is expressed as follows:
Formula
n
AM = ?HPRt/n
t=1

2001 2002 2003 2004 2005
17.9% 8.73% 9.01% 11.96% 14.32%

Geometric Average - Geometric average is always less than the arithmetic mean, except when returns are equal for each period. Then, the geometric and arithmetic averages would be equal. This average is the same as the internal rate of return (IRR).

1/5(1.179)(1.0873)(1.0901)(1.1196)(1.1432)-1= 12.33%

Arithmetic Average - does not take into account the compounding effects of returns. It is good for approximating the earning rate over time, but will tend to be less accurate if returns fluctuate widely from year to year.

17.9%+8.73%+9.01%+11.96%+14.32%/5=12.38%

  1. Time-Weighted Return/Dollar - Weighted Return:
    1. Time-Weighted Return: a measure of the performance of an investment over time without regard to cash flows in either direction. This is the preferred return measure that planners use, as it strips out the bias that cash flows create with a dollar-weighted return.
    2. Dollar-Weighted Return: a measure of performance of an investment over time, only here cash flows figure into the return calculation, giving effect to inflows and outflows of money.
Measures of Investment Return (Contd.)
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: Vanguard Small-Cap Value

    Find out about the Vanguard Small-Cap Value ETF, and explore detailed analysis of its characteristics, suitability, recommendations and historical statistics.
  2. Mutual Funds & ETFs

    ETF Analysis: Vanguard Intermediate-Term Corp Bd

    Learn about the Vanguard Intermediate-Term Corporate Bond ETF, and explore detailed analysis of the fund's characteristics, risks and historical statistics.
  3. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  4. Savings

    What Women Investors Are Doing Right

    Women's risk aversion, penchant for research – and lack of male-style "irrational exuberance" – means their investing strategies often put them ahead.
  5. Investing Basics

    Explaining Risk-Adjusted Return

    Risk-adjusted return is a measurement of risk for an investment or portfolio.
  6. Investing Basics

    Calculating the Margin of Safety

    Buying below the margin of safety minimizes the risk to the investor.
  7. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  8. Mutual Funds & ETFs

    ETF Analysis: Guggenheim Enhanced Short Dur

    Find out about the Guggenheim Enhanced Short Duration ETF, and learn detailed information about this fund that focuses on fixed-income securities.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI KLD 400 Social

    Find out about the iShares MSCI KLD 400 Social exchange-traded fund, and learn detailed information about its characteristics, suitability and recommendations.
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  3. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  6. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  4. How does being overweight in a particular sector increase risk to a portfolio?

    An investor who is overweight in a particular sector risks a loss in value for the portfolio if there is a downturn in that ... Read Full Answer >>
  5. What are the primary risks an investor should consider when investing in the retail ...

    The retail sector consists of companies operating in multiple industries such as specialty retail, general retail, food and ... Read Full Answer >>
  6. What risks do I face when investing in the insurance sector?

    Like all equity investments, insurance companies present investors with market risk. Insurance companies, like banks, also ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!