Daily Gains Letter

Two Ways to Counter Volatility’s Toll on Your Portfolio

By for Daily Gains Letter | Mar 27, 2013

270313_DL_zulfiqarSometimes, to evaluate their portfolio performance, investors might look at the starting and ending values of their portfolio, or the simple rate of return, but they forget about the most important part—the risk they took to get there.

The simple rate of return only gives investors a percentage change in their portfolio, and nothing more than that. If someone wants to be a better investor, they must consider the amount of risk they took in order to get that rate of return and how their portfolio reacts to swings in the overall market.

To better evaluate their portfolio, investors can look at a few other measures, aside from the simple rate of return, including portfolio standard deviation and the portfolio beta.

Portfolio Standard Deviation

The name “standard deviation” may sound very demanding at first, but at the very core, it gives investors an idea about the volatility in their portfolio or how much risk their portfolio holds. Investors can calculate this portfolio evaluation measure with a simple calculator or with the help of “Excel” within minutes.

If an investor finds that their portfolio has high standard deviation, then it means that their portfolio will have wild swings. Similarly, lower standard deviation means lower volatility in their portfolio.

Portfolio Beta

When an investor calculates the portfolio beta, they are evaluating the performance of their portfolio with the return of the overall market or a certain index. To calculate the beta of their portfolio, investors need the betas of the holdings in their portfolio and their returns. (The betas of stocks are available on financial web sites and the beta of the market is always one.)

If investors find their overall portfolio beta to be more than one, then it means their portfolio can have bigger swings than the overall stock market. Similarly, if they find their portfolio beta to be less than one, they will witness much less volatility than the markets.

The conventional simple rate of return calculation doesn’t reveal the entire picture of how the investor is achieving their return—they might be taking more risk in hindsight and may not be immune to market swings. Calculating the standard deviation and beta of their portfolio provides investors with a better measure of their risk.

Investors must learn from their performance. If they are in the stock market or in long-term investing, taking higher risks and not realizing that they are puts an investor’s portfolio in a vulnerable place, at the forefront of losses.

With all this said, there are other measures that investors can use to evaluate their portfolio performance as well.

Investors may follow many different investment strategies—buy and hold, speculation, and so on. At the end of the day, what it boils down to is how well investors performed. Keep in mind that the goal of investing is to grow money over time by minimizing risk.

Stock markets, or any other market for that matter, have one thing in common: they fluctuate. If investors use proper risk management techniques and know where the risk is coming from, then they can grow their portfolio with peace of mind.

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