Portfolio Variance

  

Categories: Metrics, Managed Funds

The purpose of an investment portfolio: to make as much money as possible, while taking as little risk as you can get away with.

Because the financial world is overrun with the graduates of highfalutin business schools and holders of various math-based degrees, this general concept can't just stand at that. It has to get slathered with lots of complicated calculations and important-sounding jargon.

The ideas we noted above (maximizing returns and minimizing risk) contribute to a concept known as modern portfolio theory (jargon alert!). Meanwhile, the risk aspect gets measured in an equation tracking what's called variance (calculation alert!). Modern portfolio theory seeks to provide a mathematical description of the risk/reward balance inherent in any portfolio. That way, fund managers can crunch the numbers and see if they really have ample diversification. Portfolio variance measures this quality. It determines whether the assets in a portfolio are too closely correlated in performance to provide meaningful diversification.

Related or Semi-related Video

Finance: What is Modern Portfolio Theory...4 Views

00:00

Finance allah shmoop what is modern portfolio theory All right

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basic idea Here people Diversification is good Dig it right

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C d i g there that's modern Alright let's goto

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a gn modern like when hunk and invested from their

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cave Well they just invested in good rocks or spears

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and really didn't worry about much else And well math

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hadn't really been invented yet So like who knew that

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If all right well then along came harry markowitz in

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nineteen fifty two who tried to science and math the

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crap out of the stock market What he came up

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with was modern portfolio theory which basically said that there

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was a smarter way to invest than just you know

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putting your life savings into blockbuster because you like the

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logo using all sorts of advanced metrics that we won't

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torture you with here The theory he devised was that

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well rather than throwing your money against the wall to

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see what sticks you could use extensive elaborate data to

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determine the best way to maximize your returns depending on

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how much risk you were willing Teo you know risk

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And there are five key ideas behind modern portfolio theory

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And yes of course we have videos on each of

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these The first is alfa which is kind of like

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how smart you are in the market Then there's beta

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which is about volatility in a broadway The vics we

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got a whole video set on that Then they're standard

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deviation and no that's not some kinky reference to fifty

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shades It's more about how the market diverges from your

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given individual stock pick and volatile things are finally the

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beta then there's our squared it's all about how a

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stock or a given index conforms to a given line

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or expected return ratio Like how close it is how

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proximate is And then finally you have the sharpe ratio

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Thank you bill sharp from stanford university who also talked

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about being smart in the market so that you could

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evaluate your rich turns whether they were smart or just

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a lottery ticket Lucky Oh and we're probably not such

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a wise investment in the beginning even though they turned

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out okay That would be sort of the sharpe ratio

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Yeah all right Well in general mpt skews toward less

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risky investments but it all comes down to risk reward

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Tolerance in the end if for whatever reason you feel

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supremely confident that radio shack is about to make a

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massive come back well you might be able to justify

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taking more risk in loading the dice But to be

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clear radio shack was just a bad example So kids 00:02:33.29 --> [endTime] don't try this at home

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