Expected return is the profit or loss an investor anticipates on an investment that has known historical rates of return (RoR). Its calculation does not only apply to a single value or asset. It can also be expanded to analyze a portfolio containing different investments. Let's see how we can use the expected profitability to our advantage and the factors to take into account.

**What is expected profitability**

The expected return is **the profit or loss an investor anticipates on an investment that has known historical rates of return (RoR)**. Is calculated **multiplying the potential outcomes by the probabilities of their occurrence and summing these outcomes**.

**What is expected profitability for?**

The calculation of expected profitability is a key piece of both business operations and financial theory, even in the well-known financial models. **modern portfolio theory (MPT)** or the Black-Scholes option pricing model. The expected return is **a tool used to determine whether an investment has a positive or negative average net result**. It is calculated as the expected value (EV) of an investment given its potential profitability in different scenarios. The expected profitability **usually based on historical data** and, therefore, is not guaranteed in the future; however, **usually sets reasonable expectations**. Therefore, the expected return figure can be viewed as a long-term weighted average of historical returns.

**Formula for calculating expected profitability**

The expected profitability and **the standard deviation** are two statistical measures that can be used to analyze a portfolio. The expected return of a portfolio is **the expected amount of return a portfolio can generate**, which makes it the mean (average) of the possible return distribution of the portfolio. When considering individual investments or portfolios, a more formal equation for the expected return on a financial investment is:

In essence, this formula states that the expected return in excess of the risk-free rate of return depends on the investment's beta, or relative volatility compared to the broader market.

**Example of calculating expected profitability**

This calculation **It does not only apply to a single security or asset**. It can also be expanded to analyze a portfolio containing different investments. If the expected profitability of each investment is known, the overall expected profitability of the portfolio is **a weighted average of the expected returns of its components.** For example, suppose we take three shares of the **Investment Ideas Substack blog**:

**Salesforce (CRM): $5.000 invested and an expected return of 15%.**

**FedEx Corp (FDX): $2.000 invested and an expected return of 6%.**

* Accenture Plc. (ACN): $3.000 invested and an expected return of 9%.* With a total portfolio value of $10.000, the weightings of Salesforce, FedEx Corp. and Accenture Plc. in the portfolio they are 50%, 20% and 30%, respectively. Therefore, the expected return on the total portfolio is:

**(50% x 15%) + (20% x 6%) + (30% x 9%) = 11,4%.**

**Limitations of the expected profitability calculation**

Making investment decisions based solely on expected return calculations can be quite risky. Before making any investment decision, **We should always review the risk characteristics of investment opportunities** to determine whether investments fit our portfolio objectives. For example, suppose we propose two hypothetical investments. Its annual profitability results in the last five years are:

**Investment A: 12%, 2%, 25%, -9% and 10%.**

* Investment B: 7%, 6%, 9%, 12% and 6%.* Both investments have expected returns of exactly 8%. However, when analyzing the risk of each one, defined by the standard deviation,

**Investment A is approximately five times riskier than Investment B**. That is, investment A has a standard deviation of 11,26% and investment B has a standard deviation of 2,28%. In addition to the expected returns,

**We must also take into account the probability of occurrence**. After all, there may be cases in which certain assets offer a positive expected return, even though the probabilities of this occurring are very low.