FIN 104: INVESTMENTS AND PORTFOLIO MANAGEMENT
PRINCIPLES OF PORTFOLIO PLANNING
Investors benefit from holding portfolios of investments rather than single investment vehicles. As discussed earlier,
a portfolio is a collection of investment vehicles assembled to meet one or more investments goals. Different
investors have different objectives for their portfolios.
a. Growth-oriented: a portfolio whose primary objective is long-term price appreciation
b. Income-oriented: a portfolio that stresses current dividend and interest returns
Portfolio Return and Standard Deviation
The return on a portfolio is calculated as a weighted average of returns on the assets (investment vehicles) from
which it is formed, thus the equation:
Rp = (w1 x r1) + (w2 x r2) + ... + (wn x rx) =
𝑛
𝑗=1
Illustration:
A. Expected Portfolio Returns
Expected Return
Year
Asset X Asset Y
2019
8%
16%
2020
10
14
2021
12
12
2022
14
10
2023
16
8
Portfoio Return Calculation
(8%x.50) + (16%x.50) =
(10%x.50) + (14%x.50) =
(12%x.50) + (12%x.50) =
(14%x.50) + (10%x.50) =
(16%x.50) + (8%x.50) =
Σ (wj x rj)
Expected Portfolio Return, rp
12%
12
12
12
12
B. Average Expected Portfolio Return, 2019-2023
Rp = 12+12+12+12+12/5 = 60/5 = 12%
C.
Standard Deviation of Expected Portfolio Returns
Sp = √ (12-12)2 + (12-12)2 + (12-12)2 + (12-12)2 + (12-12)2 / 5-1 = √0/4 = 0
The standard deviation is 0, which means no variability is shown in the expected returns.
How about uneven distribution of asset allocation? Take this example 1.
A portfolio has two assets, Asset K and Asset Q, with 50,000 and 75,000 initial investments respectively. Asset K has
recorded the following returns in the past 3 years, 12%, 15%, and 16%, whereas Asset Q has 11%, 8%, and 9%.
Compute the Rp and Sp of the portfolio.
Standard Deviation: A measure of risk
The most common single indicator of an asset’s risk is the standard deviation, s. It measures the dispersion (variation)
of returns around an asset's average or expected return.
Coefficient of Variation: a relative measure of risk
The coefficient of variation, CV, is a measure of the relative dispersion of an asset’s returns. It is useful in comparing
the risk of assets with differing average or expected returns.
Formula:
or
CV = S / R
Coefficient of variation = standard deviation/average or expected return
Exercise: Compare assets K and Q (see example 1) using SD and CV.