The Long-Term Expected Rate of Return: Setting It Right

Abstract

A number of serious, widely held errors and misconceptions about the long-term expected rate of return need to be dispelled. First, this rate need not be approximated, because exact formulas for this estimate are easy to find and apply. Second, such an approximation could be quite misleading. This article offers simple methods and exact formulas to determine the expected value and variance of the n-year horizon rate of return directly in terms of the one-year parameters. The probability distribution of that return is also brought out. Concrete examples illustrate these results.