What is 'Average Return'

Average return is the simple mathematical average of a series of returns generated over a period of time. An average return is calculated the same way a simple average is calculated for any set of numbers; the numbers are added together into a single sum, and then the sum is divided by the count of the numbers in the set.

The simple average of returns is an easy calculation, but it is not very accurate. For more accurate returns calculations, analysts and investors also frequently use the geometric mean return (sometimes called the time-weighted return), or the money-weighted return.

There are several return measures. Three of the most popular are return on assets (ROA), return on investment (ROI) and return on equity (ROE).

BREAKING DOWN 'Average Return'

One example of average return is the simple arithmetic average. For example, suppose an investment returns the following annually over a period of five full years: 10 percent, 15 percent, 10 percent, 0 percent and 5 percent. To calculate the average return for the investment over this five-year period, the five annual returns are added together and then divided by 5. This produces an annual average return of 8 percent.

In business, there are three main ways to calculate return. One way is with a simple growth formula, where the return on the investment is a function of growth. Other measures of return, such as ROI, ROA, and ROE, focus on investment performance rather than growth.

Return From Growth

The simple growth rate is a function of past and present values. It is calculated by subtracting the past value from the present value and then dividing by the past value. The formula is: (Present - Past) / Past.

For example, if you invest $10,000 in a company and the stock price increases from $50 to $100, the return can be calculated by taking the difference between $100 and $50 and then dividing by $50. The answer is 100 percent, which means you now have $20,000.

More Accurate Average Return Measures

When looking at average of historical returns, the geometric average is a more precise calculation. One benefit of using the geometric mean is that the actual amounts invested do not need to be known; the calculation focuses entirely on the return figures themselves and presents an "apples to apples" comparison when looking at two or more investments' performance over more various time periods. The geometric average return is sometimes called the time-weighted rate of return (TWRR) because it eliminates the distorting effects on growth rates created by various inflows and outflows of money into an account over time. The geometric formula is:

[(1+Return1) x (1+Return2) x (1+Return3) x ... x (1+Returnn)]1/n - 1

Alternatively, the money-weighted rate of return (MWRR) incorporates the size and timing of cash flows, so it is an effective measure for returns on a portfolio that has received deposits, dividend reinvestments, interest payments or has had withdrawals. The money-weighted return is equivalent to the internal rate of return (IRR) where the net present value (NPV) = 0. The MWRR is calculated using this formula:

Average Return on Assets and Return on Equity

ROA, also referred to as return on average assets and return on investment (ROI), is a function of profit margin and asset turnover. The rate of return on assets is both a profitability and efficiency measure. ROA is calculated by dividing net income by average total assets. For example, assume the net income of Company A grows from $1 million to $2 million, while assets increase from $10 million to $100 million. Using the basic growth formula, we know that net income rose by 100 percent, while assets grew by 1000 percent. This may sound great, but the return on assets is only 3.6 percent.

ROE is calculated by dividing net income by shareholders' equity. It measures asset efficiency and the degree to which the company is using debt to pay for assets. For example, if Company A has stockholders' equity of $1 million one year and $10 million the next, it means ROE is calculated by dividing $2 million by the average of $1 million and $10 million, or $5.5. The answer is 36 percent.

RELATED TERMS
  1. Annual Return

    Annual return is the compound average rate of return for a stock, ...
  2. Geometric Mean

    The geometric mean is the average of a set of products - the ...
  3. Dividend-Adjusted Return

    The dividend-adjusted return is a calculation of a stock's return ...
  4. Total Return

    Total return is a performance measure that reflects the actual ...
  5. Portfolio Return

    Portfolio return is the gain or loss achieved by a portfolio. ...
  6. Return on Equity (ROE)

    Return on equity refers to the profitability returned in direct ...
Related Articles
  1. Investing

    How to calculate your investment return

    How much are your investments actually returning? The method of calculation can make a significant difference in your true rate of return.
  2. Investing

    Breaking Down The Geometric Mean

    Understanding portfolio performance, whether for a self-managed, discretionary portfolio or a non-discretionary portfolio, is vital to determining whether the portfolio strategy is working or ...
  3. Investing

    Earnings Power Drives Stocks

    Internal return on investment helps determine a stock's ability to propel shareholder returns.
  4. Investing

    Use ROA To Gauge A Company's Profits

    Do you rely too heavily on ROE? Consider using return on assets for a more complete picture.
  5. Investing

    How to calculate required rate of return

    The required rate of return is used by investors and corporate-finance professionals to evaluate investments. In this article, we explore the various ways it can be calculated and put to use.
  6. Managing Wealth

    3 Steps to Assess Your Portfolio's Annual Performance

    Learn about three simple steps you can use to evaluate the annual performance of your investment portfolio, and why rate of return isn't enough.
  7. Small Business

    How to Calculate NPV Using XNPV Function in Excel

    Learn how to calculate the net present value (NPV) of your investment projects using built-in functions from Excel using the XNPV function.
  8. Investing

    Overcoming Compounding's Dark Side

    Understanding how money is made and lost over time can help you improve your returns.
  9. Small Business

    Calculating IRR with Excel

    Find out how to calculate the internal rate of return on investments using Microsoft Excel, as illustrated in different investment scenarios.
RELATED FAQS
  1. What's the difference between arithmetic and geometric averages?

    An arithmetic average is the sum of a series of numbers divided by how many numbers being averaged. However, geometric average ... Read Answer >>
  2. What are some examples of applications of the geometric mean?

    Learn about applications of the geometric mean based on examples such as calculations of portfolio return, growth rates and ... Read Answer >>
  3. What are the main differences between return on equity (ROE) and return on assets ...

    ROE gauges how their investments are generating income; ROA measures how management is using its assets or resources to generate ... Read Answer >>
  4. How do you calculate return on assets (ROA)?

    Return on assets (ROA) is a profitability ratio that measures how well a company is generating profits from its total assets. Read Answer >>
  5. How do I calculate my year-to-date (YTD) return on my portfolio?

    Learn how to calculate the YTD return of a portfolio, including examples of year-to-date calculations, with and without interest ... Read Answer >>
Trading Center