Hi beautiful people in this video I will explain arithmetic average return arithmetic average return formula arithmetic average return calculation with the help of an example after explaining arithmetic average return then I will explain geometric average return geometric average return formula and geometric average return calculation with help of a simple example in the end I will show you why.
Geometric average return always less than arithmetic average return now I will explain to you to calculate geometric average return the geometric mean is the average of a set of products the calculation of which is commonly used to determine.
The performance results of an investment or portfolio in general if we have two years of returns the geometric average return over these two years is calculated using this formula step one take each of the T annual returns R 1 R 2 R T and add one to each after converting them to decimals step 2 multiply all the numbers from step one together step three take.
The result from step two and raise it to the power of 1 over T step four finally subtract 1 from the result of step three the result is the geometric average return let me explain.
The geometric average return with help of simple example a stock has had returns of 13 percent 20 percent 22 percent minus 11 percent 27 percent and minus 5 percent over the last six years what are the geometric average return step one take each of the six stock annual returns converting them to decimals and add one to each stock step 2 multiply all the numbers from.
One point one three one point two zero one point two two zero point eight nine one point two seven and zero point nine five together step three take the result from from step.
Two and raise it to the power of one over six step four finally subtract one from the result of step three the result is the geometric average return 10.50% one important point you must remember the geometric average return will always be less than the arithmetic average return if the returns have any variation in our previous calculation arithmetic returns for the stock 11 percent and geometric average return for the stock ten point zero five percent.
It is clear that geometric average return always less than arithmetic returns if you thought this video was valuable please give it a thumbs up subscribe and leave a comment.
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