Reviewed by Gotrade Internal Analyst
Expected return is a foundational concept in investing. It helps investors estimate what they might earn from an investment over time, given different possible outcomes and their probabilities.
While expected return is not a promise, it provides a rational framework for comparing opportunities and making informed decisions.
Understanding what is expected return and how the expected return formula works allows investors to think in probabilities rather than predictions.
What Is Expected Return?
Expected return is the average return an investor expects to earn from an investment, calculated by weighting each possible return by its likelihood.
It does not describe what will happen in a single scenario. Instead, it represents what an investor would expect over many similar investments or over long periods.
Expected return is expressed as a percentage and focuses on outcomes, not certainty.
Theory Behind Expected Return
Expected return comes from probability theory.
Risk and reward relationship
In finance theory, higher expected returns are usually associated with higher risk.
Investors demand higher expected returns to compensate for uncertainty and potential losses. This relationship forms the basis of many asset pricing models.
Expected return in portfolio theory
Modern portfolio theory uses expected return as a key input.
Each asset has an expected return, and portfolio expected return is the weighted average of the expected returns of its components.
This helps investors balance risk and return at the portfolio level.
Market expectations vs personal expectations
Expected return can be based on market assumptions or personal estimates.
Different investors may assign different probabilities and expected returns to the same investment.
Calculating Expected Return
Expected return can be calculated in a structured way.
The basic expected return formula is:
Expected Return = (P₁ × R₁) + (P₂ × R₂) + … + (Pₙ × Rₙ)
Where:
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P represents the probability of an outcome
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R represents the return of that outcome
The sum of all probabilities equals 1.
Calculation
Assume a stock has two possible outcomes next year:
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60 percent chance of gaining 10 percent
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40 percent chance of losing 5 percent
Expected Return = (0.60 × 10%) + (0.40 × −5%)
Expected Return = 6% − 2% = 4%
This means the average expected return is 4%, even though no single outcome equals 4%.
Expected return for portfolios
For portfolios, expected return is calculated by weighting each asset’s expected return by its allocation.
This highlights how asset allocation decisions shape overall expectations.
Practical Examples of Expected Return
Examples show how expected return is used.
Stock investment example
An investor evaluates a growth stock with high upside and high downside.
By assigning probabilities to different scenarios, the investor estimates whether the expected return justifies the risk.
ETF comparison example
Two ETFs may have similar past performance but different expected returns based on:
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Asset exposure
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Risk profile
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Market outlook
Expected return helps compare them beyond historical returns.
Long-term investing context
Over long periods, expected return becomes more meaningful.
Short-term results may vary widely, but expected return helps guide strategic allocation.
Limitations of Expected Return
Expected return has important constraints.
Depends on assumptions
Expected return is only as good as the assumptions behind it.
Incorrect probabilities or biased expectations lead to misleading results.
Does not measure risk
Expected return alone ignores volatility and downside risk.
Two investments can have the same expected return but very different risk profiles.
Not a forecast
Expected return is not a prediction. Actual returns can differ significantly from expected values, especially in the short term.
Sensitive to rare events
Low-probability, high-impact outcomes can distort expected return estimates.
These events are difficult to model accurately.
How Investors Use Expected Return
Expected return is a planning tool.
Comparing investment options
Expected return allows investors to compare assets on a consistent basis.
It helps evaluate whether potential rewards justify the risks taken.
Portfolio construction
Investors use expected return to allocate capital across assets.
Higher expected return assets may receive higher weight if risk tolerance allows.
Setting realistic expectations
Expected return encourages probabilistic thinking.
This reduces emotional reactions to short-term outcomes.
Expected Return vs Realized Return
The difference matters.
Expected return
Represents what an investor anticipates on average. It is forward-looking and assumption-based.
Realized return
Represents what actually happened. It is backward-looking and influenced by randomness.
Good decisions can still lead to poor realized returns in the short term.
Conclusion
Expected return is a core concept that helps investors think in probabilities rather than certainty. By understanding what expected return is, the theory behind it, and how to apply the expected return formula, investors gain a structured way to compare opportunities and design portfolios.
While expected return has limitations and relies on assumptions, it remains a valuable tool for long-term planning and disciplined decision-making.
When evaluating stocks or ETFs, combining expected return analysis with risk measures inside the Gotrade app can help you build a portfolio aligned with your goals and tolerance for uncertainty.
FAQ
What is expected return in investing?
Expected return is the probability-weighted average return an investor expects from an investment.
Is expected return guaranteed?
No. It is an estimate, not a promise.
How is expected return calculated?
By multiplying possible returns by their probabilities and summing the results.
Why is expected return important?
It helps investors compare investments and plan portfolios rationally.
Reference:
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Investopedia, Expected Return, 2026.
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Wall Street Prep, Expected Return Formula, 2026.
