Risk Adjusted Return: When investors compare the returns of their portfolio or the performance of two investment options, they usually look at the return on investment. Although this method is not the best.
Risk Adjusted Return: Generally, when investors compare the returns of their portfolio or the performance of two investment options, they only look at the return on investment. However, this way of comparing investment options is not the best. Investors should not only take their decision on the basis of returns but also take into account the risk taken to achieve it. Risk-adjusted returns are the only way to measure it. It is helpful in comparing portfolios apart from various individual securities and mutual funds.
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Risk calculation is important before investing.
Talking about investment, risk provides better opportunities, the more risk you take, the higher will be the chances of getting higher returns. In such a situation, do not stay away from investing in any option just because of the risk. However, for this it is important that you first understand how much risk you can take and how much risky security you can keep in your portfolio. Risk calculation is important in many ways-
- Measuring risk is a logical and objective way of knowing the capabilities of your fund manager, advisor or financial consultant. Ideally, the fund manager aims to generate high returns with minimal risk.
- By measuring the risk, you can separate your high risk investments from less risky investments and without any contradictions you can know how much return on investment you have actually got.
- Risk-adjusted returns help measure performance, volatility, index alignment and quality.
- Risk-adjusted returns are a good way to measure the performance of a fund manager.
- Standard deviation is a better way to measure volatility.
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This is how the risk-adjusted return is calculated
There are mainly five methods for measuring risk-adjusted returns- alpha, beta, R-squared, standard deviation and Sharpe ratio.
- Alpha: If you want to know how your investment is doing, alpha is the better way to measure it. Under this, the return on investment is compared strongly with benchmark indices like Sensex, Nifty. Alpha can be used to track the talent of the fund manager or portfolio as it can easily find out whether you are getting higher return on investment than the benchmark.
- Beta: Beta is a method of measuring volatility and beta also tells how much risk is taken in the investment compared to the market. Its value being more than one means that your investment option is more volatile as compared to the market.
- Standard Deviation: Standard deviation measures the variation in the return of an asset over a period of time from its average return, that is, how much is the return on investment over a period of time relative to the average return. . This is a very important method as it can measure how stable the returns from the asset are.
- R-squared: The relationship between the price trends of the portfolio with the benchmark can be understood through R-squared. The Alpha is about performance while the R-squared is tied to the movement. Its value can range from one to hundred percent and the higher it is, the more it indicates that the portfolio is moving in the direction of the benchmark. Its low value means that the portfolio is not growing along with the index.
- Sharpe Ratio: The Sharpe Ratio measures how much return the investor has taken according to the amount of risk he has taken. Under this, the return on the capital invested is deducted from the return that would have been received if the capital was invested in risk-free instruments like government securities. This difference is then divided by the asset’s standard deviation, which is the Sharpe ratio. The higher it is, the higher the risk reward or higher the return.
(This article is for information only. Investing in market-linked securities is subject to market risks. Therefore, before taking any investment decision, please consult your advisor.)
(Input: Mirae Asset Mutual Fund)
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