Question

Provide a brief discussion of approximately 250 words detailing the risks inherent in stock returns in a portfolio of shares using the concepts of standard deviation and diversification as a basis.

Answer 1

Stock Market Returns are the returns that the investors generate out of the stock market. This return could be in the form of profit through trading or in the form of dividends given by the company to its shareholders from time-to-time.  Stock Market Returns can be made through dividends announced by the companies. The most common form of generating stock market return is through trading in the secondary market.

Standard deviation is a statistical measurement that sheds light on historical volatility. For example, a volatile stock will have a high standard deviation while a stable blue chip stock will have a lower standard deviation. A large dispersion tells us how much the fund's return is deviating from the expected normal returns.

Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries, and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event.

Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk.

However, that no matter how diversified your portfolio is, risk can never be eliminated completely. You can reduce risk associated with individual stocks, but general market risks affect nearly every stock, and so it is also important to diversify among different asset classes. The key is to find a happy medium between risk and return; this ensures that you can achieve your financial goals.