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Old 08-28-2013, 11:02 AM   #21
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Originally Posted by Fred123 View Post
Here's an example: suppose you have $100 invested in the stock market. After year 1, the stock declines by 50%. The next year the stock increases by 100%. After two years, you have $100. But the average return is (-50+100)/2 or 25%. If you had invested the stock in a CD earning 1%/year, you would have (roughly) $102. The average return is only 1%. Yet you've earned more money in the second case.
I don't think one can calculate average rate of return using different piles of starting cash and then merging them together into an average. In the above case the 50% loss is on a pile of cash that is twice as large as the 100% gain. That has to be taken into account. When you do so the average return is 0%.

Obviously, you have picked up on that since you were not fooled by the 25% return. I thought I would make it clear why the math does not work.
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Old 08-28-2013, 11:25 AM   #22
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Join Date: May 2013
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Originally Posted by Chuckanut View Post
I don't think one can calculate average rate of return using different piles of starting cash and then merging them together into an average. In the above case the 50% loss is on a pile of cash that is twice as large as the 100% gain. That has to be taken into account. When you do so the average return is 0%.

Obviously, you have picked up on that since you were not fooled by the 25% return. I thought I would make it clear why the math does not work.
My bad. I'd always assumed that mutual fund returns were reported as arithmetic rather than geometric means, but it turned out to be one of those "facts" that you think are true but aren't true at all. And learning that is one of the many advantages of participating in these forums!
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