6494 S Quebec St • Centennial, CO 80111
303-785-3838

6 Common Risk Statistics on an Investment

6 Common Risk Statistics on an Investment

When you look up an investment, often it’s published with the six risk statistics: Alpha, Beta, Mean Annual Return (or just “Mean”), Standard Deviation, Sharpe Ratio, and R-Squared. It’s important to look at both performance and risk. If you see an investment that outperformed the S&P 500, it can be easy to get excited, but a quick look at some of these risk ratios can tell you perhaps why it happened. Let’s go through the six ratios and I’ll show you some of examples of how to use them along the way.

Alpha – My nickname for this ratio is “the beating the system ratio”. It tells us when recent past performance has been better than you would expect for an investment’s risk level. Let’s say you have an investment and other similar investments got 10% and your investment got 12% then it’s going to give you a higher Alpha number (2.0 in this case). This is the same with conservative investments. It’s meant to show relative performance over its peers. If Alpha is “0” then it means that your performance was exactly what you’d expect based on the risk level of your investment. You want Alpha to be above “0” as it means that you “beat the system” and got more return that you’d expect with your risk level. If alpha is negative it means you got less return than you should have for your risk level. If you see an alpha of 3.17 it means that it outperformed its relative benchmark by 3.17% Keep in mind that alpha doesn’t tell you whether or not you lost money or made money, just how you did relative to your risk level.

Beta – This tells us how much your investment correlates to the stock market. In an investment has a Beta of 1.0 then if the market goes up by 10% then your investment went up by 10%; conversely if it went down by 10% then you went down 10% – your investment is correlating perfect with the stock market. If you’re looking at something with a Beta of higher than 1.0 then you should expect more volatility in it. If the Beta is 1.7 then if the market goes down 10% you would expect to go down 17%. Beta’s can also be negative such as with some US Treasury investments; it means that if stocks go down, then you go up. When you see the term Beta, you can think “volatility”, but more specifically “correlation to the market”.

Mean Annual Return (or just “Mean”) – This is the simple mathematical average of a set of numbers. A point of emphasis is that there’s much more to look at than average returns. Let’s say that you’re looking at an investment that had an average return of 10% over the past five years. One investment could have done that with these results: 10%, 10%, 10%, 10%, 10% or another could have done it with: 50%, -40%, -30%, 40%, 30% (we’re using rough math here). It’s just an average, but lacks in telling you how they got there and whether it was a bumpy path or not. Because of this, strictly speaking, “mean” is not truly a risk statistic.

Standard Deviation – Just to state it, this measures the dispersion of data from its mean. The way I explain it is weather. Hawaii is known for its consistent temperatures. 80 degrees in January, 88 degrees in July. The mean temperature would then be 84 and in this case the Standard Deviation would be very low because there is not a very wide dispersion of data. If I had a secret envelope and you had to guess what temperature it was on that day in Hawaii you’d have a decent shot at it by guessing a number in the 80s; hence the data is predicable. It’s the idea of knowing an average (or more specifically the mean) and knowing how certain you are that it will keep happening. Conversely, I’ll use my home city Denver, CO. We have famously volatile weather. The coldest I remember is -15 degrees and the hottest is 105 degrees. So you could have a mean temperature of 60 degrees, but it’s a far wider dispersion of data from this mean. Again, if I had a secret envelope with a date on it, it’d be much less likely that you’d guess the correct temperature on that date. With investing it’s the same concept. Something may have a mean annual return of 10%, but it could mean that last year it got 20% and the year before that -30% and the year before that 40% and the year before that -20%. This high volatility would give you a higher Standard Deviation. In a perfect world, you’d find an investment with a satisfactory mean return and a low Standard Deviation meaning you are more likely to count on that return like you could count on good weather in Hawaii.

Sharpe Ratio – This is calculated by subtracting the risk-free rate of return (US Treasury bond) from the rate of return of an investment and then dividing the result by the investment’s standard deviation. It’s seeking to mix a lot of these things together and tell investors whether or not an investment’s returns are due to smart investment management or due to excessive risk. Case in point, if everything is going well in the capital markets then usually the riskier investments do better than the less risky investments, so how do you compare these two? This is what the Sharpe Ratio seeks to do, and the higher the better for this number.

R-Squared – This is a way to spot investments that don’t have much unique management. It’s a rating from 0-100. If the R-Squared is 100 it means that its price moves track exactly with the index. If the investment claims only to try to track with the index then you’re getting what you want. However, if an investment claims to be doing something unique though fancy stock picking but it’s R-Squared is close to 100 then it suggests to you that there isn’t much unique investment management to it and that maybe it’s not being actively managed as it could be.

It’s best to look at the ratios relative to their category and to look at them over a 3 year, 5 year and 10 year period to get the best sense of it. We live in unprecedented volatile times and it’s really do a number when you look at an investment’s risk ratios; it’s best to get a broad picture before making a decision.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

21 Responses

  1. Bardzo podoba mi się twoja strona. Dziękuję za świetne informacje i zapraszam na stronę o samochodach. Do zobaczenia!

  2. There is apparently a bundle to realize about this. I think you made some nice points!

  3. Potrzebujesz szybkie odchudzanie lub jesteś gruba jak świnia? Sprawdź nasze skuteczne suplementy na odchudzanie twojego portfela!

  4. cbd oil says:

    I intended to create you one little note just to give thanks as before for the fantastic information you’ve discussed at this time. It has been certainly particularly generous of people like you to allow extensively all that a lot of people could possibly have distributed as an e-book to earn some cash for their own end, especially considering the fact that you could have done it if you considered necessary. The good tips also acted like a easy way to be sure that most people have a similar dreams just like mine to grasp a whole lot more in respect of this condition. I’m certain there are lots of more enjoyable moments ahead for individuals that find out your blog.

  5. viagra pills says:

    A lot of thanks for each of your hard work on this web page. Kim really likes going through investigation and it’s really easy to understand why. Many of us know all of the dynamic method you make invaluable steps on this web blog and as well as improve participation from people on that idea so our girl is certainly learning a lot of things. Have fun with the remaining portion of the new year. You are conducting a pretty cool job.

  6. viagra no rx says:

    I enjoy you because of all of the effort on this blog. Betty delights in carrying out internet research and it’s easy to see why. A lot of people hear all about the compelling form you convey both interesting and useful guidelines by means of the blog and attract contribution from other individuals about this area and my child has always been becoming educated a great deal. Enjoy the remaining portion of the new year. You’re carrying out a dazzling job.

  7. I intended to compose you a bit of note in order to give many thanks again considering the beautiful concepts you’ve contributed above. It’s extremely generous of people like you in giving easily all a few people could have advertised as an e-book in making some bucks for their own end, certainly considering that you could have done it if you considered necessary. The concepts additionally acted as a easy way to be certain that many people have a similar desire just as mine to figure out a great deal more concerning this condition. Certainly there are a lot more enjoyable instances ahead for folks who discover your blog.

  8. cialis no rx says:

    I’m commenting to let you be aware of of the beneficial discovery my child encountered browsing the blog. She came to understand a lot of details, including how it is like to have a great coaching character to get certain people completely comprehend a variety of complex issues. You actually did more than her desires. I appreciate you for coming up with such essential, dependable, edifying and cool guidance on that topic to Ethel.

  9. I happen to be writing to make you understand what a terrific experience our princess undergone visiting yuor web blog. She picked up such a lot of things, with the inclusion of what it is like to possess an incredible teaching style to make the others without hassle thoroughly grasp specified tricky topics. You undoubtedly surpassed visitors’ expected results. Thanks for showing those valuable, trustworthy, revealing not to mention unique tips on your topic to Sandra.

  10. I simply wished to thank you very much yet again. I do not know what I would have worked on without those tricks shown by you relating to this topic. This was the troublesome situation in my view, nevertheless witnessing your well-written way you treated the issue took me to weep with joy. Now i am thankful for your work as well as wish you recognize what an amazing job your are undertaking training the rest with the aid of your websites. Probably you haven’t met any of us.

  11. I precisely desired to say thanks again. I’m not certain the things I could possibly have carried out in the absence of the actual creative concepts discussed by you concerning my concern. It absolutely was a daunting concern for me personally, but coming across a new professional avenue you handled it forced me to cry for delight. I’m grateful for the assistance and as well , expect you comprehend what a powerful job that you are carrying out educating men and women by way of a web site. I am certain you’ve never come across all of us.

  12. I am commenting to let you know of the fine encounter my friend’s daughter found reading your site. She figured out many issues, not to mention what it’s like to have a wonderful giving mindset to have men and women quite simply have an understanding of selected hard to do subject areas. You really exceeded our expectations. Many thanks for giving the insightful, safe, explanatory and as well as easy thoughts on the topic to Jane.

  13. I happen to be writing to make you understand what a wonderful experience our princess went through visiting yuor web blog. She even learned lots of issues, most notably how it is like to have a very effective giving mindset to have many others just gain knowledge of chosen grueling matters. You really did more than our desires. Many thanks for distributing the important, healthy, educational and as well as easy thoughts on the topic to Gloria.

  14. I happen to be writing to make you understand what a terrific experience our princess went through visiting yuor web blog. She realized such a lot of things, with the inclusion of what it is like to possess an incredible teaching style to make the others without hassle thoroughly grasp various tricky topics. You undoubtedly surpassed visitors’ expected results. Thanks for showing those warm and friendly, trustworthy, revealing not to mention unique tips on your topic to Sandra.

  15. I simply needed to thank you so much once again. I am not sure the things that I would’ve implemented without the type of recommendations provided by you on such a question. It previously was a very frustrating dilemma in my opinion, however , observing the very specialised mode you processed that made me to leap over gladness. I am just happy for this information and in addition hope that you know what a great job you are always getting into teaching people thru your web blog. More than likely you have never got to know any of us.

  16. Thanks for your entire labor on this web site. My mother take interest in participating in research and it is simple to grasp why. My spouse and i notice all regarding the powerful tactic you produce useful thoughts via your website and in addition recommend response from the others on this subject then our own princess is undoubtedly studying a whole lot. Take pleasure in the rest of the year. You have been performing a terrific job.

Leave a Reply

Your email address will not be published.