As the calendar turns many investors begin reviewing their annual returns as well as returns of various other investments.
Not All Investments are the Same!
Frequently, this time of the year we hear of miraculous returns of a manager, company, or fund. Many times leading a flurry of investors rushing towards the particular investment, which, as a side note may prohibit the investment from continuing it’s performance due to capacity constraints i.e. Fidelity Magellan Fund.
We are digressing, this being the time of the year that many investments are held up against the measuring stick, we want to remind investors there is more to a return than just the performance. Risk adjustments such as standard deviation, alpha, Sharpe, TobinsQ, and Expected utility just to name a few take into account the riskiness of the portfolio and how it garnered the return.
Rather than the boring Wall Street Lingo, let make this more real, as an example, an investor has the following two options:
- A single stock portfolio that has an average annual return of 15% annually for the last 20 years!
- A guaranteed return of 8% annually.
Most investors would choose the second portfolio, even though we made the spread between the two great enough to make you think. Now, let’s blur the lines a bit with our example to help you see how easy it is to forget the importance of risk adjustments.
- A single stock portfolio that has an average annual return of 15% annually for the last 20 years!
- A portfolio of 5000 stocks that has returned 8% annually for the last 20 years!
Using most any risk metric for the investor portfolio, the 8% returning portfolio was a better risk, while leading to much smaller investor dollars today (assuming equal investments made 20 years ago), the journey was enough safer to make the second investment better.
Keep in mind as a rule for investment measurement, it’s not just the destination, but the risk of the journey as well!
Have a Good Day!
JK