Calculating expected returns

How To Calculate Expected Return

Expected return (also referred to as “expected rate of return”) is the profit or loss one may expect to see from an investment.

To calculate the expected rate of return on a stock, you need to think about the different scenarios in which the stock could see a gain or loss. For each scenario, multiple that amount of gain or loss (return) by the probability of it happening. Finally, add up the numbers you get from each scenario after multiplying the returns by the probabilities.

The formula for expected rate of return looks like this:

Expected Return = (Return A X Probability A) + (Return B X Probability B)

(Where A and B indicate a different scenario of return and probability of that return.)

For example, you might say that there is a 50% chance the investment will return 20% and a 50% chance that an investment will return 10%. (Note: All the probabilities must add up to 100%.)

Next, multiply each scenario’s probability percentage by the investment’s expected return for that period.

Expected Return = (50% X 20%) + (50% X 10%)

Then, add those numbers together.

Expected Return = 10% + 5% = 15%

The expected rate of return is the return an investor expects from an investment, given either historical rates of return or probable rates of return under different scenarios. The expected return formula projects potential future returns.

To determine the expected rate of return based on historical data, it can be helpful by starting with calculating the average of the historical return for that investment. More on this calculation below.

This strategy may be useful when there is a robust pool of historical data on the returns of that particular asset type, but remember that past performance is far from a guarantee of future performance.

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