What is expected return

For instance, it may be the ER on a bond if the bond pays out the maximum return at maturity. In fact, the ER is a possible return on investment, and the outcomes are continuous, i. In portfolio analysis, the returns of a portfolio are the sum of each potential return multiplied by the probability of occurrence or weight. You can also look at it like the ER is the weighted average of potential returns of the portfolio, weighted by the potential returns of each asset class included in the portfolio.

Peter wants to see how this diversification has an impact on his investment strategy and what is the expect return of this portfolio. TaxCloud Direct Tax Software. Need Help? About us. Download link sent. Category Investing. What is Expected Return? Limitations It is not practical to make investment decisions based on the expected returns factor alone.

Related Terms. Recent Terms. CA Assisted Services. The expected return and standard deviation are two statistical measures that can be used to analyze a portfolio. The expected return of a portfolio is the anticipated amount of returns that a portfolio may generate, making it the mean average of the portfolio's possible return distribution.

The standard deviation of a portfolio, on the other hand, measures the amount that the returns deviate from its mean, making it a proxy for the portfolio's risk. Before making any investment decisions, one should always review the risk characteristics of investment opportunities to determine if the investments align with their portfolio goals. For example, assume two hypothetical investments exist.

Their annual performance results for the last five years are:. However, when analyzing the risk of each, as defined by the standard deviation, investment A is approximately five times riskier than investment B. That is, investment A has a standard deviation of Standard deviation is a common statistical metric used by analysts to measure an investment's historical volatility, or risk. In addition to expected returns, investors should also consider the likelihood of that return.

After all, one can find instances where certain lotteries offer a positive expected return, despite the very low chances of realizing that return. The expected return does not just apply to a single security or asset. It can also be expanded to analyze a portfolio containing many investments. If the expected return for each investment is known, the portfolio's overall expected return is a weighted average of the expected returns of its components.

For example, let's assume we have an investor interested in the tech sector. Their portfolio contains the following stocks:. Thus, the expected return of the total portfolio is:.

Expected return calculations are a key piece of both business operations and financial theory, including in the well-known models of modern portfolio theory MPT or the Black-Scholes options pricing model. It is a tool used to determine whether an investment has a positive or negative average net outcome. The calculation is usually based on historical data and therefore cannot be guaranteed for future results, however, it can set reasonable expectations.

Analysts review historical return data when trying to predict future returns or to estimate how a security might react to a particular economic situation, such as a drop in consumer spending. Historical returns can also be useful when estimating where future points of data may fall in terms of standard deviations.

Expected return and standard deviation are two statistical measures that can be used to analyze a portfolio. Standard deviation of a portfolio, on the other hand, measures the amount that the returns deviate from its mean, making it a proxy for the portfolio's risk. Portfolio Management. Risk Management. Tools for Fundamental Analysis. Your Privacy Rights.