Notice that as standard deviation increases, so does the return. In the above chart, once expected returns of a portfolio reach a certain level, an investor must take on a large amount of volatility for a small increase in return. Obviously portfolios that have a risk/return relationship plotted far below the curve are not optimal as the investor is taking on a large amount of instability for a small return. To determine if the proposed fund has an optimal return for the amount of volatility acquired, an investor needs to do an analysis of the fund's standard deviation.
Note that the modern portfolio theory and volatility
are not the only means investors use to determine
and analyze risk, which may be caused by many
different factors in the market. Not all investors
therefore evaluate the chance of losses the same
way - things like risk tolerance and investment
strategy will affect how an investor views his
or her exposure to risk. |