What is a Weighted Average?
Weighted average refers to the mathematical practice of adjusting the components of an average to reflect the importance of certain characteristics.
How to Calculate a Weighted Average
Here is information about five stocks.
We could average theirprices and it a day (i.e., we would calculate the average as $8.60).
However, this doesn’t take into account the issuers’ actual sizes or the number of shares outstanding (in other words, without reflecting the issuers’ true heft in the economy). The tiny companies can sway the as much as the more significant companies.
Accordingly, if one of the higher-priced stocks (Company D, in our example) has a huge price increase, the index is more likely to increase even if the other, more meaningful companies in the index decline in value at the same time.
Thus, we could create a weighted average to give more weight to the bigger issuers. We could do this by multiplying the share price by the shares outstanding, summing the totals, and then dividing by the total shares outstanding:
Why do Weighted Averages matter?
In the finance world, some indexes involve weighted averages and some do not. It is important to understand how indexes are weighted so you know what influences those indexes, what the really conveys, and whether the is relevant to your objectives.
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.
Read This Next
With more than 45,000 stocks listed on major exchanges around the world, it’s easy to throw up your...Read More →
To reduce your estate tax bill, you have 4 choices: 1. Leave it to your spouse. In general, any assets left to your spouse are exempt from estate tax. That's good. But...Read More →
It seems like there's a never ending flow of filings that public companies are required to issue by the ...Read More →