Weighted Average
BeginnerA weighted average is an average in which some values count more than others, according to assigned weights that reflect their importance or size.
In a simple average, every value counts equally. In a weighted average, each value is multiplied by its weight, the results are added up and the total is divided by the sum of the weights.
For example, suppose a course grade is based 60% on an exam and 40% on coursework. If a student scores 80 on the exam and 70 on the coursework, the weighted average is 80 times 0.6 plus 70 times 0.4, which is 48 plus 28, giving 76. A simple average would give 75, ignoring the fact that the exam counts for more.
Weighted averages are everywhere in finance. A portfolio's return is the weighted average of the returns of its holdings, weighted by how much is invested in each. A company's weighted average cost of capital weights the cost of debt and equity by how much of each it uses. Many stock indices weight companies by their size. The Consumer Price Index weights prices by how much households spend on each item.
Using the right weights is essential. Treating very different-sized parts equally can produce a misleading average.
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