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Definition of 'Expected Return'
The average of a probability distribution of possible returns, calculated by using the following formula:
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Investopedia explains 'Expected Return'
How do you calculate the average of a probability distribution? As denoted by the above formula, simply take the probability of each possible return outcome and multiply it by the return outcome itself. For example, if you 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%:
= (0.5) (0.1) + (0.25) (0.2) + (0.25) (-0.1)
= 0.075
= 7.5%
Although this is what you expect the return to be, there is no guarantee that it will be the actual return.
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