Glossary
Expected return
The probability-weighted average of possible outcomes for an investment; an estimate, not a promise.
On this page
Expected return is the average result an investment would produce if you could replay the same uncertain future many times, with each possible outcome weighted by its probability. It is a planning number, not a forecast of what will happen this year. It matters because nearly every portfolio decision, from asset allocation to the Sharpe ratio, compares expected return with the risk taken to earn it.
How it works
In practice, inputs come from history, from models such as the capital asset pricing model (the risk-free rate plus beta times an equity risk premium), or from valuation-based estimates like starting yield plus expected growth.
Common misreadings
- It is not the likely outcome. With wide dispersion, the most probable result can be far from the expected one. Measure the spread with standard deviation or scenario ranges.
- Arithmetic versus compound. Average yearly returns overstate what a buy-and-hold investor compounds. Returns of +50% and −50% average 0%, yet $100 becomes $75.
- Inputs drive everything. Small changes in assumed probabilities or premiums move the answer a lot, and historical averages carry large estimation error.