Volatility Drag (Variance Drag)
Computes volatility drag: the loss of the compound (geometric) return relative to the average (arithmetic) return, approximately volatility squared divided by two. It's the reason a portfolio that does +50% and then −50% doesn't return to the start: volatility erodes compound growth. The more volatile the asset, the larger the drag, even with the same average return. Enter the arithmetic mean return and the volatility.
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Volatility Drag (Variance Drag)
Computes volatility drag: the loss of the compound (geometric) return relative to the average (arithmetic) return, approximately volatility squared divided by two. It's the reason a portfolio that does +50% and then −50% doesn't return to the start: volatility erodes compound growth. The more volatile the asset, the larger the drag, even with the same average return. Enter the arithmetic mean return and the volatility.
Why +50% and −50% don't break even
There's a mathematical trap that confuses many people: a portfolio that rises 50% and then falls 50% doesn't return to the start, it ends with 75% of the original value. The arithmetic average of the two returns is zero, but the real result is a loss. That gap between the average return and what actually compounds has a name: volatility drag.
The cause is the asymmetry of compound growth: losses require proportionally larger gains to be recovered. The more volatile the asset, the bigger that drag, and it grows roughly with volatility squared divided by two. That's why reducing a portfolio's volatility can raise its compound return even without changing the average return.
Enter the arithmetic mean return and the volatility, both as a percentage per year. The tool returns the drag and an estimate of the geometric return, which is what you actually take home. It's an approximation, but it captures the effect well; for the exact value, compute the geometric return directly from the return series.
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Variance Swap (Settlement)
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Modigliani M² Measure
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The results provided by this tool are for general informational and educational purposes only and do not constitute professional, financial, medical, legal, tax or accounting advice. Always confirm important decisions with a qualified professional and official sources.