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Expected return on a portfolio

The expected return on a portfolio is the percentage at which the value of a portfolio is expected to increase over the course of a year. The expected return of a portfolio may differ from the results at the end of the year, known as the actual return rate. The expected return of the portfolio is calculated based on the probability of potential return of the portfolio.

Expected Return on a Portfolio
Expected Return on a Portfolio

Portfolio

A portfolio is a collection of assets traded on the market owned by an entity or an individual. The portfolio mainly consists of stocks and bonds, but may also contain precious metals, real estate and a variety of derivatives. Portfolios are assembled based on the understanding that by investing in different assets or diversifying, investors can minimize the risk of losses. At this level, investors can allocate assets in their portfolios according to their risk preferences.

Portfolio and risk

The risk that a portfolio will lose value can never be completely eliminated. This level of risk is directly correlated with the level of potential profitability. For example, a portfolio with a high level of risk is likely to offer a higher potential return than a portfolio with a low level of risk. For this reason, high-risk portfolios are made up largely of stocks, or equity. In contrast, low-risk portfolios mainly consist of fixed items, such as bonds and short-term money market securities (less than a year).

Expected rate of return

The expected return rate of a portfolio is the average value that reflects the historical risk and return of its constituent assets. For this reason, the expected return rate is only conjecture intended for financial planning and is not guaranteed. Everything is the same, Investors can expect that the actual rate of return will fall close to this figure.

Calculations

A certain portfolio usually has some results that can occur as a percentage of its return. Using historical data for securities in the portfolio, it is possible to specify a percentage probability for a small number of outcomes. The expected profit margin is calculated by first multiplying each possible profit with its fixed probability and then adding the products together.

For example

Let’s say a portfolio is identified as having three profitability: 40 percent, 20 percent, and 5 percent. There is a 10% probability of a 40% return, a 45% probability of a 20% profit and a 70% probability of a 5% profit. The expected return will be 16.5%, calculated as follows:
(0.1 times 0.4) plus (0.45 times 0.2) plus (0.7 x 0.05) equals 0.04 plus 0.09 plus 0.035 equals 0.165 or 16.5 percent

Actual profit

The actual return of a portfolio is the percentage at which the total value of the portfolio increases or decreases when measured at the end of a year. Along with the initial expected return on return, the actual return of the portfolio can be used to better understand why the portfolio performed better or worse than anticipated.

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