Average Annual Return
The average annual return refers to the average yearly return of an asset or investment portfolio over a certain period of time. It is an important investment indicator used to evaluate the long-term performance of assets or investment portfolios. The average annual return can be calculated based on different time periods, usually on an annual basis.
Definition: The Average Annual Return (AAR) refers to the average yearly return of an asset or investment portfolio over a period of time. It is an important investment metric used to evaluate the long-term performance of an asset or portfolio. The AAR can be calculated over different time periods, usually on an annual basis.
Origin: The concept of the Average Annual Return originated from the methods of calculating returns in finance. As modern financial markets developed, investors needed a straightforward way to assess long-term investment performance, leading to the AAR becoming a standard measure.
Categories and Characteristics: The AAR can be calculated using different methods, including arithmetic average annual return and geometric average annual return.
- Arithmetic Average Annual Return: Simply adds up the annual returns and divides by the number of years. It is suitable for investments with low volatility.
- Geometric Average Annual Return: Takes into account the compounding effect by multiplying the annual returns and then taking the nth root (where n is the number of years). It is suitable for investments with high volatility.
Specific Cases:
- Assume an investment portfolio has annual returns of 10%, -5%, and 15% over three years. The arithmetic average annual return is (10% - 5% + 15%) / 3 = 6.67%. The geometric average annual return is [(1+10%) * (1-5%) * (1+15%)]^(1/3) - 1 ≈ 6.27%.
- A stock has annual returns of 8%, 12%, -3%, 7%, and 10% over five years. The arithmetic average annual return is (8% + 12% - 3% + 7% + 10%) / 5 = 6.8%. The geometric average annual return is [(1+8%) * (1+12%) * (1-3%) * (1+7%) * (1+10%)]^(1/5) - 1 ≈ 6.6%.
Common Questions:
- Q: Why are the arithmetic average annual return and geometric average annual return different?
A: The arithmetic average annual return does not consider the compounding effect, while the geometric average annual return does. Therefore, for investments with high volatility, the geometric average annual return is usually lower. - Q: Can the average annual return fully reflect the risk of an investment?
A: No. The average annual return only reflects the level of returns and does not consider risk factors. Investors should also consider other metrics such as standard deviation and Sharpe ratio for a comprehensive evaluation.
