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Quoting Returns to an Investor:
Arithmetic (Mean) Return versus Geometric (Mean) Return

On the FPE1® and FPE2® you could be asked to calculate rates of return on a portfolio. You could also be tested on the pros and cons of quoting different types of return to a client. In this study tip I will explain the difference between calculating an arithmetic (mean) return (AMR) versus a geometric (mean) return (GMR). I will discus the pros and cons of each return.

Imagine that a financial advisor is talking with a client who asks the advisor two questions:

  1. How well has the S&P/TSX Composite Index performed on average over the last five years? and
  2. How well has the ABC Canadian equity mutual fund performed over the last five years?

While both questions appear to require a response based on a common return, what return to quotemakes the difference between a valid response and a misleading response?

When quoting an annual return it is important to know whether the returns each year are independent of each other, or whether the returns are dependent/linked together. If the returns are independent of each other, an arithmetic (mean) return can be quoted. If the returns are linked together, a geometric (mean) return should be quoted.

In the question, “What did the S&P/TSX Composite do on average over the last five years?”, the returns on average are independent. Assume the following hypothetical returns for the S&P/TSX composite:

2011 7%
2010 15%
2009 20%
2008 –10%
2007 18%

Click here to read more online about Arithmetic (Mean) Return versus Geometric (Mean) Return.

Sincerely,

Ron Foran, CFP, CLU, CFA, FCSI
President, Foran Financial Institute


New Capstone Course Materials Available

We are pleased to announce the new CCH/Advocis FPSC-approved Capstone Course. Course 245 is part of the new CCH/Advocis Education Program Leading to CFP® Certification. It is in self-study format and focuses on the completion of a financial plan to demonstrate the student’s understanding and application of financial planning fundamentals.

The FPSC exam structure now mandates that students wishing to challenge the second CFP examination (FPE2) complete a Capstone Course. For further details on CFP certification, visit the FPSC website.

FEBRUARY 2012

In This Issue


Quoting Returns to and Investor
Concluding Comments

Resources
CFP® Program Overview
Optional CFP® Study Aids
Advocis Member Benefits
CCH

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