No. of Recommendations: 3
This is probably much too simple for all of you, but I will post it.

An interesting concept of investing is the variance drag. If you get 30% one year, and – 10% the next year or vice versa, the arithmetic return is (30 -10)/2 = 10%. But the arithmetic return is not the true return. The true return is the geometric return given by r = sqrt(year 1 * year 2) -1. In this case, it would be sqrt(1.3 * .9) -1 = 8.17%.

What does this mean? It means that the more volatile your returns, the lower your returns. A simple example will show this. You have 1.00. It goes up 50% the first year and down 50% the next year (or vice versa). What do you end up with. 75 cents.
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