The expected return for an investment portfolio is the weighted average of the expected return of each of its components. Components are weighted by the percentage of the portfolio’s total value that each accounts for. Calculating the weighted average of portfolio assets can also help investors assess the diversification of their investment portfolio.
In addition to calculating expected return, investors also need to consider the risk characteristics of investment assets. This helps to determine whether the portfolio’s components are properly aligned with the investor’s risk tolerance and investment goals.
Expected return is based on historical data, so investors should take into consideration the likelihood that each security will achieve its historical return given the current investing environment. Some assets, like bonds, are more likely to match their historical returns, while others, like shares, may vary more widely from year to year.
The rate of return for each item, investment, or share within a portfolio. This could be an individual CAPM calculation for each share or another valuation method to work out the expected return, depending on the type of investment.
Weight of each investment or share within a portfolio. For instance, if you purchase $1,000 worth of share A and $1,000 worth of share B, the weight of share A and share B would both be 50% of the total volume of the portfolio.
The estimated expected return on a portfolio after accounting for the individual expected return of each item within a portfolio and the weight that item holds within that portfolio.
To calculate a portfolio's expected return, an investor needs to calculate the expected return of each of its holdings, as well as the overall weight of each holding. Once the investor has a value for expected return and a percentage weight for each asset within the portfolio, the Expected Return for a Weighted Portfolio can be calculated as follows:
Assume you had a portfolio containing investments in Share A, Share B, and Share C. Share A is valued at $2,000 with a return of 12%. Share B is valued at $1,000 and has a return of 15%. Share C has a value of $1000 and a return of 11%. The share weight can be calculated by dividing the value of the share within the portfolio by the total value of the portfolio, which is $4,000.
ERi = (X1*ER1) + (X2*ER2) + (X3*ER3)
ERi = (0.5*0.12) + (0.25*0.15) + (0.25*0.11)
ERi = 0.125 = 12.5%
Using the Expected Return on a Weighted Portfolio formula, the value for the expected return for this portfolio is 12.5% for the investor.
The Expected Return on a Weighted Portfolio formula allows investors to calculate the expected return on a portfolio of investments, giving them insight into what the expected return on a diversified portfolio could be. This can influence investment decisions as investors can shift invested value weights within a portfolio to better hedge their investments and achieve the optimal or maximum return possible.
It is important to note, however, that Expected Return on a Weighted Portfolio is calculated with historical data and doesn’t take into consideration changing economic conditions that may affect the result of the Expected Return.
The estimated expected return on a portfolio after accounting for the individual expected return of each item within a portfolio and the weight that item holds within that portfolio. Although not a guaranteed predictor of share performance, the expected return formula has proven to be an excellent analytical tool that helps investors forecast probable investment returns and assess portfolio risk and diversification.
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