Expected Return

Expected return

The expected return on a risky asset, given a probability distribution for the possible rates of return. Expected return equals some risk-free rate (generally the prevailing U.S. Treasury note or bond rate) plus a risk premium (the difference between the historic market return, based upon a well diversified index such as the S&P 500 and the historic U.S. Treasury bond) multiplied by the asset's beta. The conditional expected return varies through time as a function of current market information.

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Expected Return

The return on an investment as estimated by an asset pricing model. It is calculated by taking the average of the probability distribution of all possible returns. For example, a model might state that an investment has a 10% chance of a 100% return and a 90% chance of a 50% return. The expected return is calculated as:

Expected Return = 0.1(1) + 0.9(0.5) = 0.55 = 55%.

It is important to note that there is no guarantee that the expected rate of return and the actual return will be the same. See also: Abnormal return.

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Expected Return

What Does Expected Return Mean?

The average of a probability distribution of possible returns. It is calculated by using the following formula:

Investopedia explains Expected Return

One calculates the average of a probability distribution by taking the probability of each possible return outcome and multiplying it by the return outcome itself. For example, if one knew a given investment had a 50% chance of earning a 10% return, a 25% chance of earning 20%, and a 25% chance of earning -10%, the expected return would be equal to 7.5%: Expected Return = (0.5) (0.1) + (0.25) (0.2) + (0.25) (-0.1). Although this is what one would expect the return to be, there is no guarantee that it will be the actual return.

Related Terms:
• Coefficient of Variation
• Equity Premium
• Return on Assets
• Return on Equity
• Total Return

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Expected Return

The expected return is used to figure the taxable portion of pension that is taxed under the general rule. For a lifetime pension, it is computed by multiplying the annual pension by the applicable expected life multiple from government actuarial tables.