Volatility drag

The gap between the arithmetic mean of a series of returns and the compound rate actually achieved, which widens the more the series moves around.

Example

+50% then -50% averages 0% arithmetically while 100,000 becomes 75,000 - a two-year compound rate of -13.40%.

Important

Neither figure is wrong; returns multiply rather than add, so the arithmetic mean is simply not the average that describes compounding, and it is always at least as large as the compound rate.

Related terms

• CAGR (compound annual growth rate) — The single steady annual growth rate that would take a starting value to an ending value over a given number of years.
• Compounding — Earning returns on your past returns, not only on your original money.
• Drawdown — The decline from an investment's highest point to its lowest point before it recovers.

Lessons that explain it

• CAGR: the smoothed rate, and the path it deletes — Compound annual growth rate is the straight line drawn between two points. Two investments with identical CAGRs can be completely different experiences to live through. (11 min)

All 578 terms in the Investing glossary