The utility in calculating such things are for comparative purposes. It may not be all that relevant to someone in your own personal situation, but it is a means of looking at two or more different investments to see which one is taking on more risk per unit of return than the other. This could be an important consideration for an investor because the potential is greater for the riskier investment to suffer a big drawdown going forward. Just because assuming additional risk may have worked in the past there are no guarantees that it will continue to do so in the future.hboy43 wrote:Thank you Scott for the links. I read a bit and don't see the whole idea as useful in the long run in terms of having the biggest pile of money after a lifetime of saving and investing, if one can be rational. Surely actual average returns of say 10% PA that are highly volatile and lead to a risk adjusted number of say 8, is a bigger pile in 20 or 30 years than an actual average return of 9 that risk adjusts to 8.scomac wrote: This may help. The article suggests using the Sharpe ratio as a means of determining risk adjusted return for a single security. From there you could derive a portfolios risk-adjusted return.
I guess it all comes down to "rational". Most are not, so it seems to me this is a tool to keep folks in the game in the short term at the cost of the long term to a avoid a situation like 2008 where an individual quits the market and hides in GICs for the rest of their lives.
Is my assessment fair here or have I completely missed the point?
Hboy43
In my own situation I have fifteen years or so now of tracking information and I've been looking at segmented returns to try and see where I'm adding value and perhaps where I'm not. Essentially I'm trying to determine where assuming risk has been beneficial and where it hasn't. This has led me to rethink what I've been doing. That was behind me recently selling most of my preferred share exposure as well as dialing back on small cap exposure. I've done well with those investments over the years, but not without assuming considerably more risk that with comparable investments in bonds and large cap stocks. The ratios of winners to losers spelled that out pretty clearly without having to get into esoteric calculations.
It doesn't make for exciting cocktail party conversation, but it was enlightening to learn that I don't need to do some of the things I had been doing to achieve the required rate of return. It isn't quite as simple as a highly volatile 10% netting you 8% risk adjusted versus a less volatile 9% netting a similar number. The differences tend to be quite a bit starker than that when taking on materially different levels of risk. With my own analysis that was working out to about a 1.7% difference per annum less return from small stocks versus large. My conclusion is why bother.