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Geometric Mean
Geometric Mean
Return?
What is a geometric mean return?
A geometric mean return is an average return that considers compounding and is the
standard metric for conveying return performance for investments.
When investment
professional refer to the average annual return, they are referring to the geometric average
annual return.
$100
$110
$105
$112
Year
Return
$100
$110
$110-100
=0.10 or 10%
$100
$105
$105-110
=-0.0455 or -4.55%
$110
$112
$112-105
=0.0667 or 6.67%
$105
Return
1.1000
0.9545
1.0667
This is an adjustment to consider that the investments value is compounded such that the initial
value is invested and the return is an adjustment to that value. For example, if you invest $1 and
earn 6% on that $1 during the period, the value at the end of the period is $1 x (1 + 0.06) =
$1.06.
Note: There are only 3 periods returns in this analysis because we have prices for four periods.
Because we need two prices to calculate a return, there are only three returns for this series.
An alternative
Another way of calculating this, since we have a starting and an ending value is to consider the
following:
PV = $100
FV = $112
n=3
and solve for i. The i in this calculation is the compounded growth rate over the three-year
period (a.k.a. the geometric average return). 1
i = 3.8499%
Some rounding was used to simplify this example. The precise answers for both methods will be the same
in all cases, but you may see slight differences if you round in the calculation of the period returns.
2
Blume, M.E., Unbiased Estimators of Long Run Expected Rates of Return, Journal of the American
Statistical Association, Col. 69, No. 347 (September 1974), and Indro, D. C., and W. Y. Lee, Biases in
Arithmetic and Geometric Averages as Estimates of Long Run Expected Returns and Risk Premia, Financial
Management, Vol. 26, No. 4 (Winter 1997).