Arithmetic Average Rate of Return Calculator

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Arithmetic Average Rate of Return

function calculateArithmeticAverageReturn() { var investment1 = parseFloat(document.getElementById("investment1").value); var investment2 = parseFloat(document.getElementById("investment2").value); var investment3 = parseFloat(document.getElementById("investment3").value); var investment4 = parseFloat(document.getElementById("investment4").value); var investment5 = parseFloat(document.getElementById("investment5").value); var resultDiv = document.getElementById("result"); if (isNaN(investment1) || isNaN(investment2) || isNaN(investment3) || isNaN(investment4) || isNaN(investment5)) { resultDiv.innerHTML = "Please enter valid numbers for all investment returns."; return; } var totalReturn = investment1 + investment2 + investment3 + investment4 + investment5; var numberOfYears = 5; // Assuming 5 years of returns for this example var averageReturn = totalReturn / numberOfYears; resultDiv.innerHTML = "The Arithmetic Average Rate of Return is: " + averageReturn.toFixed(2) + "%"; }

Understanding the Arithmetic Average Rate of Return

The Arithmetic Average Rate of Return, often referred to as the simple average return, is a straightforward method for calculating the average performance of an investment over a specific period. It is calculated by summing up the individual period returns and then dividing by the number of periods.

How it Works

For each period (e.g., year), you determine the rate of return. This return is typically expressed as a percentage. For example, if an investment grew from $100 to $110 in a year, the return is 10%. If it then dropped to $104.50 in the next year, the return for that year would be -5%.

The formula for the Arithmetic Average Rate of Return is:

Arithmetic Average Return = (Sum of Period Returns) / (Number of Periods)

It's important to note that the arithmetic average does not account for compounding. This means it treats each period's return independently and doesn't reflect how returns from one period would affect the base for the next period's calculation. For a more accurate picture of long-term investment growth, especially over many periods, the Geometric Average Rate of Return is often preferred.

When to Use the Arithmetic Average

Despite its limitations regarding compounding, the Arithmetic Average Rate of Return is useful for several reasons:

  • Simplicity: It's easy to calculate and understand.
  • Short-Term Analysis: It can provide a quick snapshot of performance over a few periods.
  • Comparing Investments: It can be used to compare the average performance of different investments side-by-side, as long as the comparison is made over the same number of periods.
  • Forecasting: It can be used as a simple basis for future return expectations, though this should be done with caution.

Example Calculation

Let's consider an investment with the following annual returns:

  • Year 1: 10%
  • Year 2: -5%
  • Year 3: 15%
  • Year 4: 8%
  • Year 5: 12%

To calculate the Arithmetic Average Rate of Return:

Sum of Returns = 10% + (-5%) + 15% + 8% + 12% = 40%

Number of Periods = 5

Arithmetic Average Return = 40% / 5 = 8%

Therefore, the Arithmetic Average Rate of Return for this investment over the five-year period is 8% per year.

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