finiki: Risk and Return

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
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Shakespeare
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finiki: Risk and Return

Post by Shakespeare » 09 May 2012 08:43

A new finiki section on Risk and Return has been contributed by Lady Geek, using Canadian data from Libra Investment Management (Norbert).

Risk and return - finiki

Image

The effect of the 208 crash is shown below:

Image

Comments are welcomed.
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Re: finiki: Risk and Return

Post by scomac » 09 May 2012 12:12

I don't have any hard numbers at my fingertips, so I'm just working from memory, but the differential between expected loss and actually 2008 loss seems askew to me. IIRC, according to something that I read in your Primer, Shakes; the maximum expected loss was something in the order of 10% for a 50/50 portfolio. The graph suggests that it is less than 5%. To get expected losses down to levels as low as that would require a maximum equity exposure of 30% or less.
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Re: finiki: Risk and Return

Post by Shakespeare » 09 May 2012 12:24

My primer uses the estimates of Bernstein. I repeated them in finiki in this section. For convenience I'll copy the table below:
The maximum expected losses as a function of the equity percentage as estimated by Bernstein[4] are given in the following table:

Code: Select all

 Risk of Loss
 Maximum|Equity
    Loss|Percentage
    35% 	80%
    30% 	70%
    25% 	60%
    20% 	50%
    15% 	40%
    10% 	30%
    5% 	20%
    0% 	10% 
The Value at Risk calculation LadyGeek uses underestimated the losses - which she points out.
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Re: finiki: Risk and Return

Post by BRIAN5000 » 09 May 2012 13:31

From my humble fumbling around to me it looks like the expected return and loss are wishful thinking. The expected return for a 30/70 over the last 38ish years would be more like 4% and to get that return you must be able to face down years almost 1 out of 3. (from Vanguards calculator and IIRC checked with Norm's asset mixer)
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Re: finiki: Risk and Return

Post by George$ » 09 May 2012 13:47

Shakes:

There is some overlap with several Howard Mark's newsletters

2006-January at http://www.oaktreecapital.com/MemoTree/ ... _19_06.pdf

2006-June at http://www.oaktreecapital.com/MemoTree/ ... _13_06.pdf

2004-Oct at http://www.oaktreecapital.com/MemoTree/ ... 02704).pdf

Have look - it may be a helpful reference?

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Re: finiki: Risk and Return

Post by Shakespeare » 09 May 2012 14:02

Thanks, George$. That section is LadyGeek's, so I'll let her answer the various points when she is available.

Nevertheless, the point in your refs that higher risk is the expectation (or hope) of higher returns, not the promise, is very well taken.
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Re: finiki: Risk and Return

Post by LadyGeek » 09 May 2012 22:26

My intent is to show the basic concepts of risk and return to help new investors - there's a reason why you need to own both bonds and stocks.

With regards to the portfolio composition, using treasuries and the TSX/Composite has no questions on the underlying data source. It's also simple for new investors to understand. The detailed composition is in the Notes.

A possible difference in results is that Shake's table uses the FPX Indexes, where Risk and return is actual return data - not an index. The FPX composition is here.

I read the newsletters, but I'm hesitant to include them. Howard Mark first defines risk as shown in finiki, then proceeds to change the definition. It's the opinion of a single (but knowledgable) person, but I don't think represents a consensus on investment risk definition. For comparison, take a look at this publication: Mismeasurement of risk in financial planning, Richard K. Fullmer, CFA, October 2009. There are many definitions of risk and is why I used a very simple, accepted definition.

To Shake's point (as noted by George$): There might be some confusion on the use of "expected" return - it's intended as mathematical average and stated in the footnotes. Perhaps this could be worded better?
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Re: finiki: Risk and Return

Post by Shakespeare » 09 May 2012 22:35

A possible difference in results is that Shake's table uses the FPX Indexes
The table I referred to in this thread, and reposted above, on risk of loss, is from Bernstein and The Intelligent Asset Allocator. He wrote it before the 2008 crash. It is the second table in the finiki section Portfolio Design and Construction - finiki, not the first. The first is a hypothetical portfolio based on assumed returns, not real data.
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Re: finiki: Risk and Return

Post by LadyGeek » 10 May 2012 17:18

I added this thread as a reference ("External links"), so this discussion becomes part of finiki. Link to the article: Risk and return - finiki

The definition for expected return has been updated (it's in the footnotes):
finiki wrote:Expected return is a weighted average of an investment's future ("expected") return; and can be different than the actual return.
Shakespeare wrote:The table I referred to in this thread, and reposted above, on risk of loss, is from Bernstein and The Intelligent Asset Allocator. He wrote it before the 2008 crash. It is the second table in the finiki section Portfolio Design and Construction - finiki, not the first. The first is a hypothetical portfolio based on assumed returns, not real data.
My mistake. Your reference on the 2nd table was to Bernstein's The Four Pillars of Investing, which I have. He used the chart as part of an investor questionnaire and didn't explain the details. I think that's what got me confused - to which table you were referring.

On the topic of risk, I'll continue the discussion in View topic - Risk = ??.

To George$ - This thread will show my reluctance to include your newsletters. It's not a simple answer. (Actually, it is, but getting agreement is extremely difficult.)
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Re: finiki: Risk and Return

Post by Shakespeare » 10 May 2012 18:18

My mistake. I didn't check the ref when I posted above; it was Four Pillars not IAA in finiki. :oops: I thought I had a similar table in my Primer, but a quick glance doesn't show the same format.
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Re: finiki: Risk and Return

Post by LadyGeek » 10 May 2012 20:23

No problem.

If anyone has anything they'd like to update or correct in this finiki article, please post here - this is a collaborative effort. You don't need to be a finiki editor. (Any forum member interested in editing finiki is welcome to apply here.)
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Re: finiki: Risk and Return

Post by Arby » 23 Nov 2012 12:33

A publication on "Financial Market Returns: Past, Present and Future" provides an easy to read assessment of the risk and return of various asset classes. The article is from a Canadian company, but is based on US data.

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