The Difference Between Arithmetic and Geometric Returns

The more volatile an investment is, the bigger the difference there'll be between arithmetic return and geometric return. An extreme case might be that you gave all your money to Bernie Madoff and you were making 8% a year for 30 years. But then in the last year you lose 100% because it turns out that the whole thing was a giant Ponzi scheme. It's really dangerous really to think about arithmetic returns rather than geometric returns as they don't accurately reflect what you're going to be left with at the end of your investment period.

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