Let me just start off with an example.
You have five years of return data from your portfolio.

Years/Returns

• 1- 10%

• 2- 18%

• 3- 21%

• 4- -3%

• 5- 17%

The way most people calculate their returns is to add all of them up and divide by the amount of years. Your average annual return would be 12.6% ((10+18+21+ (-3) +17)/5) =12.6).

This seems like the correct answer right? Not really. Let me show you another example so you can see the flaw using this kind of equation.

You purchased a mutual or stock at $100.00 per unit and it does not pay any dividends. The first year it goes down to $50.00 per unit. The second year it doubles up to $100.00 per unit. You would assume that you didn�t make or lose any money right? Well wrong again. Using the same equation your annual return would be 25%!

Years/Returns

• 1- 50%

• 2- 100%

• (-50+100)/2= 25%

Now that you see why the conventional way of finding your return is flawed and delivers false returns, let’s view the real way to calculate your return.

1st. You have to change all your returns to decimals. After that use this equation to find your real return.

((1 + (1st yr. return)*

(1+ (2nd yr. return)*

(1+ (3rd yr return)*

(ect….)) ^ 1/ (number of years)-1

We will use the information from the first example.

((1+.10)*(1+.18)*(1+.21)*(1-.03)

*(1+.17)) ^ 1/5=.122 *100% = 12.2%

I know this equation involves a calculator and an extra one minute of work, but it shows you the real return on your investments which is crucial.