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The weighted average return is a method of measuring the performance of a stock portfolio that takes into account how much capital is placed in each investment. Since more money might be placed in certain assets than in others, it makes sense that these assets should have more of an effect on the performance of a portfolio as a whole. To calculate this number, each asset should be measured in terms of its rate of return and the percentage of the entire portfolio that it encompasses. Multiplying these two percentages for each asset and then adding all of them together will yield the weighted average.
Investors generally are interested in knowing how all of the different securities in which they place their money are doing. Ultimately, what matters the most is how the entirety of their portfolio is performing. This can be difficult to measure if these different securities have various amounts of money placed in them. Luckily, investors can use a measurement known as the weighted average return as a way of judging the performance of an entire portfolio at once.
As an example of how weighted average return works when judging an investment portfolio, imagine that an investor has placed money in three different stocks. He bought $1,000 US Dollars (USD) worth of Stock A, $1,500 USD of Stock B, and $2,500 USD of Stock C. At the end of the year, Stock A gained by four percent, Stock B gained by five percent, and Stock C gained by six percent.
Simply adding up the three percentage gains and dividing them by three leaves an arithmetic mean of five percent on the rates of return. That does not take in to account the fact that Stock C accounted for half of the entire portfolio, while Stocks A and B combined for the other half. Weighted average return accounts for this by first noting how much of the portfolio each stock comprised. In this case, Stock A was 20 percent, or $1,000 USD out of $5,000 USD total, Stock B was 30 percent, and Stock C was 50 percent.
Knowing these totals, weighted average return can now be calculated by multiplying the percentage of the portfolio each stock takes up by the rate of return on each. For Stock A, it is 0.2 multiplied by the four percent return, or .8. The other two totals are five percent multiplied 0.3 for Stock B, or 1.5, and six percent multiplied 0.5 for Stock C, or 3.0. Adding all of these totals up yields a weighted average of 5.3 percent, which is a truer indicator of the portfolio return than the arithmetic mean of the individual returns.
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