We are independent & ad-supported. We may earn a commission for purchases made through our links.
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.

What is an Expected Return?

By D. Poupon
Updated May 17, 2024
Our promise to you
WiseGeek is dedicated to creating trustworthy, high-quality content that always prioritizes transparency, integrity, and inclusivity above all else. Our ensure that our content creation and review process includes rigorous fact-checking, evidence-based, and continual updates to ensure accuracy and reliability.

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

Editorial Standards

At WiseGeek, we are committed to creating content that you can trust. Our editorial process is designed to ensure that every piece of content we publish is accurate, reliable, and informative.

Our team of experienced writers and editors follows a strict set of guidelines to ensure the highest quality content. We conduct thorough research, fact-check all information, and rely on credible sources to back up our claims. Our content is reviewed by subject-matter experts to ensure accuracy and clarity.

We believe in transparency and maintain editorial independence from our advertisers. Our team does not receive direct compensation from advertisers, allowing us to create unbiased content that prioritizes your interests.

An expected return is the value that investors expect an asset to earn or lose on average over a given time period. More precisely, it is the sum of all possible financial outcomes of an asset that are weighted by the probability of the outcome’s occurrence. Easily calculated using a tree diagram, if an asset has a 70 percent chance of earning 6 percent and a 30 percent chance of earning 9 percent in a year, then the expected return of the asset is calculated as 6.9 percent. The interest, dividends, and capital gains and losses of assets affect their expected returns. Also referred to as the mean return, it is an investor’s best predictor of future market behavior.

Actual Versus Expected Returns

In contrast to an expected return, an actual return is the reported amount that an asset gained or lost over a given period. A total return is an asset’s actual return over an investment horizon, including reinvestment rates. It is very unlikely that an asset’s actual return will be exactly the same as the expected return, so an asset is considered "on stream" if its actual and expected returns are sufficiently close. If an asset has significantly underperformed or outperformed the predicted return, then it is called an abnormal return, which might occur because of mergers, interest rate changes, or lawsuits, all of which affect the particular asset instead of the market as a whole.

Prediction Methods

In order to detect and exploit abnormal returns, investors rely on a variety of methods to accurately predict the expected return of an asset. Besides the tree diagram calculation mentioned earlier, another simple method is to take the historical mean of past annual returns. The historical mean is not a bad estimate if a company has a long history, has accurate historical data, and has made few changes in its structure, policies and strategies. On the other hand, the calculation does not take into consideration volatility, which is a measure of the price variation of investment options from year to year, and therefore is a rather primitive estimate.

Risk-free Assets

Some economists have noticed that risk-free assets, such as bonds, have unexplained, lower, long-term total returns than more volatile assets such as stocks. As a result, risk-free assets can negatively affect the calculation of an expected return. The economists Edward C. Prescott and Rajnish Mehra called this phenomenon "the equity premium puzzle," which economists have struggled to understand. Equity premium is the excess return that is left over when risk-free assets’ returns are subtracted from the expected market return. Modern economic models such as the Capital Asset Pricing Model (CAPM) attempt to solve the equity premium puzzle by estimating the expected return of risk-free assets differently from risky assets. The model takes into consideration the volatility of risky assets and their sensitivity to changes in the market.

WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Discussion Comments
WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.

WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.