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Define Your Risk

Investment portfolios have risk. Downturns occur periodically. Companies grow and mature. Some companies whither and die. Statistics can help you quantify your portfolio's risk.

If your portfolio is diversified enough that its monthly returns can be modeled as a normal (Gaussian) distribution or bell curve, then statistics can be used to figure out the probability of different returns. Additionally, although the probability distribution is two sided, positive and negative, when talking about risk, the only concern is for the negative side.

For example, the monthly volatility, or standard deviation, of the S&P 500 from 12/31/71 through 1/31/17 was 4.38%. The average monthly return during this time was 0.94%. If the S&P 500 is normally distributed then there is a 15.9% probability the monthly return will be lower than -3.4% (one standard deviation below the mean). There also would be a 2.3% probability the monthly return would be lower than -7.8% (two standard deviations below the mean) and a 0.14% probability, the monthly return would be lower than -12.2% (three standard deviations below the mean).

Annualized volatility is calculated for ProFolio's model portfolios. This is the annualized standard deviation of the portfolio. For example, based upon the statistical model, there is a 15.9% probability (or once in every 6 years) there will be return lower than the annualized return minus the annualized volatility.



The information presented here is the opinion of the author and may quickly become outdated and is subject to change without notice. All material presented in this article are compiled from sources believed to be reliable, however accuracy cannot be guaranteed. No person should make an investment decision in reliance on the information presented here.

The information presented here is distributed for education purposes only and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or participate in any particular trading strategy.

Performance data showing past performance results is no guarantee of future returns.

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