Expected Return Calculator
Calculate the probability-weighted expected return of an investment portfolio.
Investment Details
Scenario Analysis
Define potential market outcomes. Probabilities must sum to 100%.
What is Expected Return Rate?
The Expected Return Rate (ER) is a key financial metric used to evaluate the potential profit or loss of an investment by accounting for the likelihood of different outcomes. Unlike a simple average, the expected return is a probability-weighted average. It combines the potential returns of various scenarios (such as a bull market, a stagnant market, or a recession) with the statistical probability of those scenarios occurring.
How the Calculation Works
To calculate the expected return, you must multiply the potential return of each outcome by its probability, and then sum these results. The formula is:
ER = (P1 × R1) + (P2 × R2) + … + (Pn × Rn)
- P: Probability of the outcome (as a decimal or percentage).
- R: Return rate of that specific outcome.
For example, if an investment has a 50% chance of gaining 20% and a 50% chance of losing 10%, the expected return is not 5% (the simple average), but rather calculated as: (0.50 × 20%) + (0.50 × -10%) = 10% – 5% = 5%.
Why Use an Expected Return Calculator?
Investors use this calculation to make rational decisions under uncertainty. By quantifying the "average" outcome over repeated trials, investors can determine if the potential reward justifies the risk. It is widely used in:
- Portfolio Management: To estimate the aggregate growth of a diversified set of assets.
- Capital Budgeting: Companies use it to decide which projects to pursue.
- Risk Assessment: Helping investors visualize downside scenarios alongside optimistic ones.
Limitations
It is important to remember that the Expected Return is a long-term statistical average. It does not guarantee the actual return of a single investment event. An investment with a positive expected return can still result in a loss if a negative scenario (like a market crash) occurs.