The formula: sum of returns ÷ number of periods
For five years of returns — 12%, 8%, 15%, -3%, and 20% — adding them together gives 12 + 8 + 15 − 3 + 20 = 52, and dividing by 5 periods gives an average return of 10.4%.
What the other figures show
Alongside the average, the lowest return in that same list was -3% and the highest was 20% — a 23-percentage-point spread, showing this "typical" 10.4% return came from years that individually looked quite different from each other.
Why this is called a "simple" average
This arithmetic mean treats every period's return as an equally-weighted number, with no regard for the order they happened in or how they compound together over time — it's a purely statistical summary of the list of numbers, not a measure of actual realized growth.
When this can be misleading
Because it ignores compounding, arithmetic average return can overstate how much an investment actually grew, especially when returns are volatile — a concrete demonstration of exactly how large that gap can get is in the companion article comparing average return to CAGR.