What Is Mean Return?
Mean return, in securities analysis, is the expected value, or mean, of all the likely returns of investments comprising a portfolio. A mean return is also known as an expected return or how much a stock returns on a monthly basis. In capital budgeting, a mean return is the mean value of the probability distribution of possible returns.
Understanding Mean Return
Mean returns are calculated by adding the product of all possible return probabilities and returns and placing them against the weighted average of the sum. When calculating a mean return through the return probability formula to display portfolio return, it is often referred to as a geometric mean return since it evokes the formula for means used in geometry. However, the simple geometric mean does not adequately capture the full scope of the mean return as used in the stock market. The geometric mean return formula is primarily used for investments that are compounded, while other simple interest accounts average mean could be found by simply adding the rates and divided by the time periods. Alternatively, a geometric mean return formula can illustrate the rate per period of a holding period return, with the holding period return acting as the total return over multiple periods of time.
Capital budgeting finance mean returns are calculated a little differently, but similarly. The formula for capital budgeting uses maximum risk-tolerance weighted returns instead of the probabilities of the return.
Mean returns are not the same as average monthly returns, because a mean return would only reflect the average return if the time period used in the calculation was exactly a year and if all the probably weights happened to be precisely the same, which is improbable. Thus, mean return is more of a broad term instead of an average monthly statistic over a period of time.
The Benefits of Mean Return
Mean returns attempt to quantify the relationship between the risk of a portfolio of securities and its return. It assumes that while investors have different risk tolerances, rational investors will always seek the maximum rate of return for every level of acceptable risk. It is the mean, or expected, return that investors try to maximize at each level of risk.
Mean returns can also help investors more accurately visualize a proportional change in wealth over the time horizon and through analysis, show what the rate wealth could potentially continue at.