How to Calculate Expected Rate of Return

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Expected Rate of Return Calculator

Understanding Expected Rate of Return

The Expected Rate of Return (ERR) is a projected profit or loss an investment is expected to generate over a specific period. It's a crucial metric for investors to compare different investment opportunities and make informed decisions. A higher expected rate of return generally indicates a more attractive investment, assuming comparable risk levels.

How to Calculate Expected Rate of Return

The formula to calculate the Expected Rate of Return is as follows:

ERR = [ (Final Value of Investment – Initial Investment Amount) / Initial Investment Amount ] * (1 / Time Period in Years) * 100%

Let's break down the components:

  • Initial Investment Amount: This is the principal amount of money you initially put into the investment.
  • Final Value of Investment: This is the total value of your investment at the end of the specified time period, including any gains or income generated.
  • Time Period (in years): This is the duration over which the investment has been held or is expected to be held, expressed in years.

Example Calculation:

Suppose you invested $10,000 (Initial Investment Amount) in a stock that is now worth $12,000 (Final Value of Investment) after 2 years (Time Period).

  • Profit = $12,000 – $10,000 = $2,000
  • Total Return = ($2,000 / $10,000) * 100% = 20%
  • Expected Annual Rate of Return = (20% / 2 years) = 10% per year

Using the formula:

ERR = [ ($12,000 – $10,000) / $10,000 ] * (1 / 2) * 100%

ERR = [ $2,000 / $10,000 ] * 0.5 * 100%

ERR = 0.2 * 0.5 * 100%

ERR = 0.1 * 100%

ERR = 10%

Therefore, the expected annual rate of return for this investment is 10%.

Important Considerations:

It's important to remember that the Expected Rate of Return is a projection. Actual returns can vary significantly due to market fluctuations, economic conditions, and other unforeseen factors. This calculation provides a useful baseline for comparison but should not be considered a guarantee of future performance.

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