# What is the Definition of Expected Return?

Learn about the definition of expected return and how it impacts investment decisions. Discover the importance of calculating expected returns and see real-world examples in action.

## Understanding Expected Return

Expected return is a crucial concept in the world of investing that essentially represents the average return an investor can anticipate on an investment over time. It is a key metric used by investors to evaluate the potential profitability of an investment and make informed decisions about where to allocate their capital.

## Calculation

The expected return of an investment can be calculated using the following formula:

• Expected Return = (Probability of Return A * Return A) + (Probability of Return B * Return B) + …

## Importance

Expected return provides investors with a baseline for evaluating the risk and reward trade-off of an investment. By comparing the expected return of various investment options, investors can make decisions that align with their risk tolerance and financial goals.

## Example

Consider an investor who is deciding between two investment options: Option A has an expected return of 8% with a probability of 70%, while Option B has an expected return of 12% with a probability of 30%. By calculating the expected return of each option, the investor can make an informed decision based on their risk preferences and desired returns.

## Case Study: Company X

Company X is considering launching a new product line that has the potential to generate substantial returns. After conducting market research and financial analysis, the company estimates that there is a 60% probability of earning a return of 15% and a 40% probability of a return of 5%. By calculating the expected return of the new product line, Company X can assess the viability and potential profitability of the investment.

## Statistics

Studies have shown that investors who actively incorporate expected return calculations into their decision-making process tend to outperform those who do not. By carefully evaluating the expected returns of different investment opportunities, investors can optimize their portfolios and achieve their financial objectives.