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What is Arithmetic Mean?
The arithmetic mean is a term used in mathematics and statistics to describe the sum of a collection of numbers divided by the count of numbers. Simply put, the arithmetic mean is the average of a set of numbers. The arithmetic mean is a crucial concept in all fields of life, such as science, finance, statistics, economics, etc.
While the arithmetic mean of a set of numbers represents its central tendency, it can be influenced by anomalies or outliers in the given set. Therefore, for a skewed distribution, the arithmetic mean may not be truly representative of the midpoint. On the other hand, other statistics, such as the median, provides a much better representative midpoint because it ignores the extremes in a set.
What is the formula for Arithmetic Mean?
The formula to calculate the arithmetic mean of a set of numbers is straightforward, which is as below.
Arithmetic Mean = (a1 + a2 + a3 + … + an) / n
In the above formula, ‘an‘ represents the value of the nth number in a given set. On the other hand, ‘n’ denotes the count of numbers in the set. In order to calculate the arithmetic mean of numbers in observation, it is necessary to calculate the sum of those numbers first. By putting the sum in the above formula and dividing it by the count of the elements in the observation, one can get its arithmetic mean.
How does Arithmetic Mean help in finance and investing?
The arithmetic mean is a crucial concept in the world of finance and investing. For instance, investors can estimate their mean earnings using the arithmetic mean formula. Similarly, they can calculate the average returns on several stocks. Furthermore, investors can use it to calculate a stock’s average closing price during a particular period.
The most important advantage of using the arithmetic mean in the world of finance and investing is that it is straightforward to calculate and comprehend. Any investor with even basic knowledge of mathematics can calculate the arithmetic mean for different aspects of a given stock or investment. It is useful in calculating or estimating the central tendency providing more valuable results even if there are a large number of elements.
What are the limitations of Arithmetic Mean?
The arithmetic mean does not always produce the best results, especially in cases when anomalies or outliers exist in a given set. These outliers can skew the average or mean substantially. As mentioned, in these cases, there might be better measures or formulas to calculate a closer central tendency instead of using the arithmetic mean.
In other cases, such as when investors need to calculate the performance of their investment portfolios, especially when it consists of compounding or reinvestments, arithmetic mean can be futile. Similarly, it may not produce the best results when calculating present and future cash flows used by analysts in making estimates. Using arithmetic mean in these circumstances can produce inconsistent results.
Conclusion
Arithmetic is a concept in mathematics that describes the sum of a collection of numbers divided by the count of numbers in a set. It is useful in finance and investing and is used to calculate various averages. However, it may have some limitations as well.
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