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July 01, 2011 at 08:00 PM
I have often heard agents suggest that averaging should be used to measure index movement if one thinks the market will be volatile. Such an approach would be used instead of measuring the index gain or loss from one start point to one end point–the annual point-to-point method.
The belief is that averaging fares better when the market is moving around a lot. The reality is, no, averaging does not usually result in a higher index gain, except in the early stages of a bear market.
In both the 2000 and 2008 bear markets, averaging the daily or monthly values extended the positive gains for a couple of months past the period when the APP method turned negative. However, when the bull market returns, averaging delays a return to positive territory.
A look back
If you look at 12-month periods over the past decade and use an annual reset approach, the mean annual S&P 500 index return was 8.14 percent. By contrast, a monthly averaging approach produced a mean return of 4.56 percent, or 56 percent of what the APP calculation generated. Does that mean averaging methods produced half the returns of APP methods?
No, and for a couple of reasons. The first is that most approaches, especially APP methods, use caps that limit the gain, but averaging methods usually have higher caps. If you apply a 10 percent APP cap and a 12 percent averaging cap, averaging produces 76 percent of what the APP method does.
