RiskMetrics - Risk and Performance
Risk and Performance
You need to consider risk to understand your investment performance
The world is return-focused
Historically, the focus of most investors has been on tracking returns, while neglecting how much risk was taken to generate the returns. Return information is ubiquitous in newspapers, Internet sites and financial statements, while risk information is difficult to come by. Every quarter, investors see popular magazine rankings of the highest returning mutual funds, with the implicit assumption that these were the best performing funds. However, in order to judge investment performance, we must understand how much risk was taken to generate those returns.
Return on risk
The ability to include risk analysis in investment decisions allows investors to change their asset allocation in a way that enhances their return on risk. As we'll demonstrate later on, for most portfolios the return on risk can be improved: that means it is possible to either increase expected return while maintaining the same risk level, or to keep the same expected return while decreasing risk.
Rather than focusing on maximizing returns, the smart investor selects opportunities that are attractive based on their return on risk. This is important because sometimes the promise of a big return, simply may not be worth the risk.
Which apple would you pick?
The biggest apple is not always the best!