THE TRADE-OFF BETWEEN
RISK AND RETURN
6-1 Understanding returns
6-2 The history of returns (or, How to get rich slowly)
6-3 Volatility and risk
6-4 The power of diversification
GOING GLOBAL IS GOOD FOR YOUR PORTFOLIO
A report produced by Wealth Foundations, an
Australian financial advisory company, studied the
performance of one portfolio invested entirely in
Australian shares and one portfolio consisting of
shares from other countries. Data was taken from
January 1982 to December 2007. The average return
on Australian shares was 14%, while the average
return on the international share portfolio was just
12.7%. However, to earn the higher returns on
Australian shares, investors had to endure greater
volatility. The standard deviation (a statistical
measure of volatility) of the Australian share portfolio
was 16.9% per year, compared to a standard
deviation of just 15.2% for the international portfolio.Portfolio Return Standard deviation
Australia 14.0% 16.9%
International 12.7% 15.2%
Combined 13.8% 13.6%The purpose of the Wealth Foundations report
was to reinforce what finance textbooks have taught
for years: diversification benefits investors. When
Wealth Foundations constructed a diversified
portfolio that combined shares from Australia and
other countries, weighted with 60% in Australian
equities and 40% in international equities, it found
that the diversified portfolio earned a return nearly
as high as the ‘Australia-only’ portfolio (13.8%).
However, the combined portfolio had less volatility
than either the Australian or the international share
portfolio. In other words, by diversifying, Australian
investors could substantially reduce the risk of their
investments without a proportionate reduction in
their returns.
Source: Wealth Foundations 2009, http://www.wealthfoundations.com.au/
foundations-of-financial-economics-diversification.html1 Extra information from http://www.credit- suisse.com/investment_banking/doc/cs_globalinvestment returns_yearbook.pdf and http://www.
wealthfoundations.com.au.
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