Risk Variance

Risk variance, what exactly are we referencing here? So it’s simply measuring the degree of risk in your investment. So risk is going to reflect the chance that investment or actual return or is it what gain or loss might it experience over a specified period of time? So is it going to be higher or lower than expected? And is, there’s a possibility that some or maybe all of the investment will be lost. So you have to take into consideration risk variance. So for that, let’s walk through a basic case study. So we’re going to use siblings Joe and Jane. And each of them inherited $1M. So here they are, Joe and Jane each with their $1M and now we’ll walk through a couple of years and see what that looks like. So with Joe, in his first year he earned 60% in the first year. And Jane earned 30%. And so both of them I would say are doing pretty well after year one. Now meanwhile, in year two, Joe lost 40% and Jane only lost 10%. So Joe is basically up 60%, down 40%. So ultimately you totally that, a plus 20% for Joe. Meanwhile Jane, plus 30%, minus 10%, plus 20%. So there they are, both plus 20% as we would see it after two years. But let’s look at that range here. So Joe is going to be between negative 40% to positive 60%. So there’s 100% variance or range that we’re talking about. Jane was negative 10% to plus 30%, so there’s a 40% variance or range in comparison to Joe’s 100%. So when you total those up, both of them again we’re plus 20%. But let’s look at the actual return. So again Jane started with her $1M, earned 30%, so went to $1.3M and then lost 10%. So lost $130K. So she’s still at what? $1,170,000 after two years. So not too bad. Meanwhile, Joe started with $1M, earned 60%, so went to $1.6M. I think Joe was probably feeling pretty good about himself, but then lost 40% which is $640K. So actually dropped down to $960K. So the point here, really bad years can ultimately really hurt you in your portfolio. The average return doesn’t necessarily mean everything. You can ultimately just like in Joe’s case still have a negative return. And a lot of times when you look at an analysis, people are potentially taking on similar risk to Joe when they say well, I’m more comfortable with Jane’s level of risk. But they don’t find themselves in that situation. So if you have a portfolio and you’re not sure what sort of risk variance you have, feel free to give us a call. We’d love to run a free, no cost, no obligation analysis.