Question:
I’ve been managing my own portfolio for about two years now. My dad just asked me what my risk-adjusted return is. I have no idea what this is much less how to answer this question. I’m in my late 30s, and I’d say I invest relatively aggressively.
Answer:
Risk-adjusted return is the measure of return per unit of risk. To measure it, you take the return on your security and subtract the expected market return, or the risk-free return of a 10-year U.S. Treasury. Then you divide by some measure of volatility like beta or standard deviation. So, it is excess return divided by the volatility of the security. More often than not, fixed income investments will have higher risk-adjusted return than equities because of the equities’ volatility.
Risk-adjusted return is a backwards looking measurement, so you have to take into consideration that the manager or the asset will continue to perform in a similar pattern in the future. We do not believe you can judge a portfolio on risk-adjusted return alone, as it may depend on how you measure standard deviation.
For example, assume you have two money managers. One buys stocks that are twice as risky as the market. He is up 11% for the year. The second manager buys stocks that are half as risky as the market, and he is up 10% for the year. If the market is up 10%, the more conservative manager, who buys stocks that are half as risky, performed better on a risk-adjusted basis than the more aggressive manager, who beat the market.
At Henssler Financial, we control risk by diversification across several sectors and industries. We are also a high quality manager in that we strive to avoid bankruptcy risk in the companies we own. Additionally, we own dividend-paying stocks, and they tend to be more stable in their price. We also aim to control risk by considering your investment time horizon. With money you need to remain safe, we recommend investing in non volatile assets. With money that is not needed within 10 years, we recommend investing in more volatile assets like stocks, in order to achieve growth.
At Henssler Financial we believe you should Live Ready, which includes understanding the level of risk you expose yourself to when investing. If you have questions regarding your investment strategy, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.