Managed Funds Harrop Financial

Tropo:

I was trying to come up with my own example that would show a difference, but the one in that document is perfect!

For those who couldn't be bothered opening the doc...

You have $100 invested, you make 100% in the first year and lose 50% in the second year.

To find the arithmetic mean (average), you add them together and divide by two. So that would be (100 + (-50))/2 = 25%

But if you do it manually, you start with $100, then make 100%, so you now have $200, then you lose 50%, so you now have $100. So you really made 0%, not 25%.

That's where the geometric mean comes in. Instead you do the following: ((1 + 100%) x (1 + 50%))^1/2 = 0%.

In this example the difference was 25%, which is huge. But in cases where your gains/losses are a lot less variable, the difference isn't as much.

As for my other point about continuous compounding, I think I should take that back. It doesn't really matter (I think) as long as everyone uses discrete periods. If someone knows otherwise, please correct me.

 

iiinvestor

I am glad, you like it...

 

That was meant to be: ((1 + 100%) x (1 - 50%))^1/2 - 1 = 0%

oops