Average portfolio return

Definition

Average portfolio return is the mean return expected from a collection of investments over a specific period, calculated by taking the weighted sum of individual asset returns. This concept is crucial for investors as it helps assess the overall performance of their investment portfolios, enabling them to make informed decisions based on past performance and future expectations.

5 Must Know Facts For Your Next Test

1. The average portfolio return is typically expressed as a percentage and can be calculated over various time frames, such as monthly, annually, or over the life of the investment.
2. Investors often compare the average portfolio return to benchmarks, such as market indices, to evaluate performance and identify potential areas for improvement.
3. The calculation of average portfolio return incorporates both realized returns (historical) and expected returns (projected), providing a comprehensive view of performance.
4. Diversification within a portfolio can impact the average portfolio return, as combining assets with varying correlations can lead to different risk-return profiles.
5. The average portfolio return plays a key role in determining metrics like the Sharpe ratio, which helps assess risk-adjusted performance by comparing excess returns to portfolio volatility.

Review Questions

• How does average portfolio return inform investment strategies and decision-making for investors?
  • Average portfolio return provides investors with a benchmark for evaluating how well their investments are performing. By calculating this return, investors can assess whether they are meeting their financial goals and determine if they need to adjust their strategies. For instance, if the average portfolio return is lower than expected or compared to a benchmark, it may prompt an investor to reevaluate their asset allocation or explore new investment opportunities.
• Discuss how diversification impacts the average portfolio return and overall investment risk.
  • Diversification can significantly affect the average portfolio return by reducing risk through exposure to a variety of asset classes. When different assets in a portfolio behave differently under various market conditions, the overall volatility decreases, potentially leading to more stable returns. However, while diversification may lower risk, it does not guarantee higher returns; therefore, investors must carefully balance their portfolios to achieve desired performance without taking on excessive risk.
• Evaluate the relationship between average portfolio return and the Sharpe ratio in assessing investment performance.
  • The relationship between average portfolio return and the Sharpe ratio is vital for evaluating investment performance in terms of risk and reward. The Sharpe ratio measures the excess return per unit of risk taken, calculated using the average portfolio return minus the risk-free rate divided by the portfolio's standard deviation. A higher Sharpe ratio indicates that an investor is achieving better returns relative to the risks involved, making it an essential metric for comparing different investments or portfolios.

Related terms

expected return: The anticipated return on an investment based on historical data or models, used to gauge potential profitability.

portfolio variance: A measure of the dispersion of returns for a portfolio, indicating the level of risk associated with the portfolio's investments.

risk-adjusted return: A return that has been modified to account for the risk taken to achieve it, providing a clearer picture of an investment's performance relative to its risk level.