How do I measure risk?

Understanding your risk profile is like quantifying your ability to sleep at night. You may be comfortable with taking more risk on your investments, thirsty for a bigger gain; or you may prefer to take a safer bet while being satisfied with a modest gain. Everybody has their own level of risk appetite depending on factors like age, income, and investment goals.

The securities you decide to hold in your portfolio, as a whole, should match the level of your risk profile - so you can sleep at night :).

How do we measure the risk of a portfolio? In the Volatility Profile level, we understand that volatility characterizes the "ups and downs" of a security. We can apply the same concept to a portfolio as a whole: the volatility of a portfolio is the daily return rates of the portfolio.

Even though everyone may have a different risk profile, given the same performance of an individual security or a portfolio, it is always more desirable to have lower risk, or volatility.

Why? Let's say a term deposit's rate were exactly the same as the return rate of Apple on the stock market. You would put it in a term deposit rather than on Apple, right? The reason is that from a term deposit you always reap the return, hence a less volatile and less risky instrument than Apple. If both the term deposit and Apple have the same return rate, you are much better off investing in a term deposit.

One of the best ways to lower the volatility of your portfolio is to diversify your portfolio. The next few levels will walk you through ways to diversify your portfolio.

How did we do?

How to Improve Sharpe Ratio

What are average excess returns?