The arithmetic average return could be the return for a stock that you’re looking at or the S&P 500. We can calculate this return, it’s actually really simple. So let’s just say that we have three periods, we have three years here which are year 1, year 2 and 3 and then we have a different return each year. So in year 1, we had a return of 25% on our stock, and then in year 2, we had a loss of 40% and in year 3, it’s gonna be a 30% gain. So in order to calculate the arithmetic average return what we’re gonna do is, we’re just gonna sum these three returns together, and then we’re going to divide it by the number of years which in this case is three years total.
Alright, so all we’re gonna do is we’re gonna say (25–40) or you can think of that as plus negative 40, however, and then add the 30. So all we’re doing is summing the 25, -40, and the 30 percent. So we add all those and that’s going to be in our numerator but then in our denominator, we’re gonna have the number of periods, the number of years.
We have three years total, so we want to get the average return per year and so when we calculate that out is actually going to come to 5. So what that means is that our arithmetic average return is 5%.