Investing basics: Average rate of return vs Real rate of return

If you decide to put some money in some investments and you want to do some research, it is important to look at the real rate of return vs the average rate of return.

Lets look at two companies.

Company A                                                  Company B
Starts with $100                                           Starts with $100

After year one -20% return                           After year one 15% return
After year two 50% return                            After year two 15% return

Both companies produced a 30% return after two years. On average, each company produced 15% return per year.


But Company B produced more money over these two years.

Company A                                                  Company B
Starts with $100                                           Starts with $100

After year one -20% return                           After year one 15% return
After year two 50% return                            After year two 15% return

End of year one $80                                     End of year one $115
End of year two $120                                   End of year two $132.25
Total rate of return 20%                                Total rate of return 32.25%
Rate of return per year 10%                           Rate of return per year 16.125%

Remember, when negative rates of returned are considered, the average rate of return will be greatly skewed.