Expected Return

Expected return is a forward-looking estimate, not a guarantee. It represents the average return an investment would be expected to produce over many possible scenarios.

One way to calculate it is to weight each possible return by its probability. For example, suppose an investment has a 30% chance of returning 20%, a 50% chance of returning 8% and a 20% chance of losing 10%. Its expected return is 6% plus 4% minus 2%, which equals 8%.

Expected returns can also be estimated using historical averages, although past performance may not reflect the future, or using models such as the Capital Asset Pricing Model, which links expected return to the risk-free rate, the investment's sensitivity to the market and the expected market risk premium.

Expected return is central to portfolio theory, which aims to build portfolios with the highest expected return for a given level of risk. A portfolio's expected return is the weighted average of the expected returns of its holdings. Because actual returns can differ greatly from expected returns, investors consider expected return together with risk.