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Investment Performance Risk & Return - Deciding Which
Are The Best Investments
When may people look to invest, they simply look at the annual
rate of return, however performance also needs to be seen in terms of risk -
reward and comparisons need to be made in terms of how the investment is doing
against others in its sector and how it compares to investments in other
sectors.
This requires a bit of time, but is time well
spent in terms of getting the best investments for you and how to combine them
for optimum risk to reward.
Below you will find some ways of assessing
the performance of an investment.
Use the tools below and you will be
able to choose your investments better and maximize rates of return. Draw downs
and Peak to Valley Draw Downs.
This is one of the most important areas
for investors to look at. Although past performance is not a guide to future
results it gives an indication of losing periods, their size and
recovery.
A drawdown is simply a fall in value for an investment and
gives an indication of downside losses that investors should be comfortable
with. A peak to valley shows the worst period of return of an investment and is
the one investors, should be prepared to expect.
Drawdowns, every
investor hates them but all investments have them, so pick investments with
drawdowns your comfortable with and always assume your worst drawdown is ahead
of you.
Standard Deviation.
The volatility of an
investment is denoted by a statistical measure known as the standard deviation
of the return rate.
Without going into complex mathematics, Just think
of standard deviation as being synonymous with volatility. standard deviation
therefore is applied to the annual rate of return of an investment to measure
the investment's volatility (risk).
The higher the standard deviation
the more volatile the investment. Low standard deviation would be present in
such areas as bank deposit accounts and bonds and high standard deviation in
higher risk products such as leveraged futures and FOREX
accounts.
Sharp Ratio.
This risk-adjusted measure was
developed by William F. Sharpe, by calculating standard deviation and excess
return to determine reward per unit of risk.
The higher the Sharpe
ratio, the better the fund's historical risk-adjusted
performance.
Sortino Ratio.
Similar to the Sharpe ratio
and looks to differentiate between harmful volatility from volatility in
general by replacing standard deviation with downside deviation in the
calculation.
The Sortino Ratio is calculated by subtracting the risk
free rate from the return of the portfolio and then dividing by the downside
deviation. The Sortino ratio measures the return to "bad" volatility.
This ratio allows investors to assess risk in a better way than simply
looking at excess returns to total volatility; it considers how often the price
of the investment rises as opposed to how often it falls.
The bigger the
Sortino Ratio is the lower the chances of large losses occurring.
Benchmarks.
Benchmarks are a way of comparing investments
so you can make meaningful comparisons within sectors and across sectors. Two
benchmarks are normally used:
1. Benchmark for Correlation Values: The
benchmark that the fund has chosen to run correlation values such as alpha,
beta, R and R squared.
2. Benchmark for Graphing: The benchmark that
the investment has chosen to graph itself against as a comparison.
Beta.
Beta is the measure of a fund's volatility relative
to the market. (most fund managers correlate themselves to the S&P 500). A
beta of greater than 1.0 indicates that the fund is more volatile than the
market, and less than 1.0 is less volatile than the market.
For
example, if the market rises 1% and a fund has a beta greater than 3.8, the
fund will rise, on average, 3.8%. For a fund with a beta of 0.5, if the market
rises 1%, the fund will rise on average, 0.5%.
The relationship is
exactly the same in a falling market. (Note that investments can have a
negative beta, as well meaning that on average they rise when the market falls
and vice versa.
A little research can pay big
dividends.
A little research using the above on your investments can
pay big dividends in getting an investment portfolio that's right for you and
could give you better growth to drawdown.
Learn More about a
Legendary Trader
Why not attend one of our FREE Seminars held in London
and cheshire. click here to book on-line or
telephone 0161 285 4488.
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