Expected returns:
Expected returns represent the return you expect to receive, based on your assessment of the investment’s potential. Importantly, they’re not guaranteed, they’re a projection, and market conditions can significantly impact them.
Key Components of Expected Returns:
-Historical Performance: The most common basis. Analyzing past returns, both positive and negative, helps gauge a potential trend.
-Market Risk: This considers the overall risk of the market, including volatility, economic conditions, and investor sentiment.
-Company-Specific Risk: This looks at the specific risks associated with a particular company, such as its business model, competitive landscape, and management quality.
-Risk-Adjusted Returns: It's the correlation between the risk you are taking and the return you expect. As the risk increase so should do the expected returns to be worth it.
Realistic expected returns:
It's important to understand what are realistic expected returns for different asset classes to make a working financial plan. To do so we can take a look at how the following assets performed in the past by picking many different random time-frames and finding out the average returns:
-All-world stocks ETF (7/10+ years): ~10%/year
-All-world stocks ETF (1/5 years): ~7%/year (less reliable expectation because of shorter time frame and possible volatility)
-High quality Gov/Corp bonds (short-term): ~2-6%/year
-High quality Gov/Corp bonds (long-term): ~4-8%/year
-Junk bonds: While these bonds offer higher interest rates the price is that they suffer much more from insolvency. This brings the statistical expected return of junk bond lower than high quality ones!
This lesson can be applied to anything else that comes to your mind:
If the expected outcome of your action isn't worth the energy/effort/money/resources you are putting into it then don't do it.
If the risks outweight the expected returns then don't do it.
Let me know if you have any questions and don't forget to check out past lessons!