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  • #16009

    Compare two stocks. Both have earned 8% per year on average. However, stock A has oscillated between 6% and 10%. Stock B has oscillated between 3% and 13%. (For simplicity, say that they alternated.) If you had purchased $500 in each stock, how much would you have had 10 years later?

    #16014
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    Solution
    Stock A –
    Rannual = finance questions image1 = 7.98%
    Stock B –
    Rannual = finance questions image2 = 7.88%
    Hence 10 years later the value of stock A was
    500*(1.0798) ^10 = $1,077.47
    While the value of stock B was
    500*(1.0788) ^10 = $1,067.53
    Instead if this stock had a constant return of 8% per year it would have returned 500*(1.08) ^10 = $1,079.46
    This is because the annualized (geometric average) rate of return is always lower than the simple arithmetic average.

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