What is average?
An average is a statistical number the is calculated by adding all numbers in a set and then dividing the sum by to the total number in the same set. The average is sensitive to outliers in the data set. One number can increase or decrease the calculated value depending on how far out the number is from the rest of the numbers in the data set.
In other words, averages are prone to outliers(big suing in value) and it is not a good idea to use the average when making a final decision. If the data has not outliers, however, the average can give a good approximation.
Instead of using average, many investors use the median. The median is not calculated by add numbers in a data set. Instead, the median is calculated by aligning all numbers in increasing order and then choose the middle number. So, the median will become the middle number. Since the values of other numbers in the set do not matter when calculating the median, a change of one number will not affect its value.
What is the formula of average?
As described above, you will need to add all numbers in a set and then divide the sum by the total numbers in the same set.
Example of average
Let’s assume that in your neighborhood, 7 houses were sold in the last month and their prices were the following.
- House 1: $50,000
- House 2: $150,000
- House 3: $200,000
- House 4: $800,000
- House 5: $250,000
- House 6: $225,000
- House 7: $300,000
Your aim is to calculate the average cost of a house in this neighborhood. You can use the following steps to calculate the average.
Step 1: Calculate the sum of all prices by adding all these numbers. With a quick calculation, the total sum becomes $1,975,000
Step 2: Count the total number of houses in our set: Our set has 7 houses. So, the total number of houses in our set is 7.
Step 3: Divide the number you find in step 1 by the number in step 2. With a quick calculation, the answer becomes $282,143
.
Our main question is: Why is the average higher than $250,000 if the majority of our numbers are equal or lower to $250,000?
We obtained a higher average value because $800,000 is an outlier in our calculation. The outlier pushed the sum much higher and generated an average that does not reflect the reality. This is why it would be wrong to say that the average cost of a house in that particular neighborhood is over $280,000.
So, to find an answer that is close to reality, we must calculate the median. To calculate the median, we need to arrange our numbers from small to big and choose the middle number.
$50,000, $150,000, $200,000, $225,000, $250,000, $300,000, $800,000. Since we have 7 numbers, our median will be the fourth number. This is because the fourth number will be in the middle no matter what side you count from.
The median of our prices = Median = $225,000. If one of these houses cost $2,000,000, our median would remain the same. However, the average would be greatly affected.
In our example, you can see that the median gives a much better answer compared to the average.
