A weighted average follows the money's proportions
A portfolio return depends on how much money was in each asset, not just the average of their returns. If 90% starts in an asset gaining 2% and 10% starts in one gaining 20%, the combined return is 3.8%. Simply averaging 2% and 20% gives 11%, which ignores the unequal starting amounts.
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Larger allocations have more influence
Consider a ₹1,000 portfolio with ₹900 in asset A and ₹100 in asset B. Over one period, A gains 2% and B gains 20%, with no money added or removed.
- Asset A earns ₹18.
- Asset B earns ₹20.
- Total gain is ₹38 on ₹1,000, or 3.8%.
The same answer comes from weighting each return by its starting share: 90% multiplied by 2%, plus 10% multiplied by 20%.
The simple average of the two returns is 11%, but that would describe equal starting allocations under the same assumptions. Deposits, withdrawals or rebalancing during the period require more careful calculations. For this one-period example, the starting weights show exactly how each asset contributes to the total result.