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Correlation and risk reduction

correlation and risk reduction

Applying the simple principles above and making correlation tables a condition of employment for your financial advisor is essential.
The integration of both qualitative and quantitative considerations are necessary in the context of an adequate solution.
For this reason the efficient frontier will usually be a curved line bending towards the left, signifying some levels of diversification.How do those two funds (Funds 3 and 7) correlation coefficients look versus the rest of the funds in the portfolio?So, what we have to do is attempt to find several assets that are responding to different forces in the economy.You want assets with a preponderance of their correlations in the.70 and lower range. .First, ask your financial advisor to provide you with correlation tables of the portfolio he is placing your account.When the correlation between the assets is 1, it means that any change in one asset is equally reflected in the change in the other asset.So, there could be a combination of A and B where the risk reduces.Lets begin with diversification.As noted earlier, each asset must be evaluated individually. Lets assume that the standard deviation code réduction nespresso 2016 of all assets are approximately the same and have a value of 20 annualized.They range from -0.09 (outstanding).48 (excellent).The average SDP (standard deviation product) is also equivalent to 4 since all assets have a standard deviation.
So, for example, if sunglasses and sunscreen are 100 correlated (having a coefficient.00 their manufacturers stock prices would move in the same direction 100 of the time.

That, however, means they are just as likely to move the same direction at any given time as they are to move in opposite directions.The reverse occurs if the portfolio is only invested in the sunscreen company: sales will be high when the sun is out, but will be poor when clouds roll.In fact, when one asset is taking a loss, theres a good chance that one of the others will be making offsetting gains.Do you see any assets in this PIN portfolio that are potentially less than ideal?What is clear from this formula is that the average standard deviation across assets is insufficient for calculating portfolio risk but this is still not clear enough to describe the levers that drive portfolio risk.Now lets look at a recent PIN portfolio: This portfolio shows an average correlation.50 (Very good to Excellent according to Table 1).Thats why loading up too much on bonds (which tend to have low returns) is not very productive.Continuing on to the right, its correlation with Fund C.73, etc.
For the standard deviation, we get.002.2.
To minimize the weather-dependent risk in the example portfolio, the investment should be split between the companies.