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Arithmetic return

The simple average of periodic returns, which overstates what you actually earned whenever returns vary.

Add the period returns and divide by the count. Four quarters of plus 20%, minus 15%, plus 25% and minus 10% give an arithmetic mean of plus 5% per quarter.

What you actually have is 1.20 x 0.85 x 1.25 x 0.90 = 1.1475, a 14.75% year, or 3.5% per quarter geometrically. The arithmetic mean of 5% implies 21.6% compounded. The gap - here nearly seven percentage points of annual return - is variance-drain, and it grows with the volatility of the series.

Arithmetic returns have legitimate uses: they are the correct input for expected-value calculations over a single future period and for most portfolio theory. They are the wrong number to report as performance, and quoting them as such is one of the most common ways track records are inflated without technically lying.

Related: geometric-return, variance-drain, annualised-return, log-return

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