Investment Theory

Geometric vs. Arithmetic Average

Consider 2 mutual funds reporting annual returns as shown in the following table. Assume you invest $100 in each, without withdrawing or adding any funds over the 5-year period.

a. What is the cumulative 5-year return for each fund?

b. For each fund, calculate the realized average annual return over the given 5-year period.

c. What might your estimate be for the expected annual return of each fund in the following year? Explain.

Fund A Fund B

1 15% 21%

2 9% -11%

3 19% 17%

4 7% 3%

5 -4% 4%