Investment Performance Risk & Return
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.
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.
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.
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 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 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.
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