Question

How do i Analyze the risk and return of two portfolios and recommend a choice to a client, providing justifications.

Answer 1

Risk and return is associated with a portfolio being a major element taking part in deciding the investment to be done on the portfolios.

Usually, when the return is high for any portfolio then it has been analyzed that it carries huge risk as well. This makes it quite a challenging job to select among the portfolios as to where to invest.

For every portfolio, the risk and return can be easily calculated. A portfolio contains two or more assets altogether. Each asset has their own return and the investment is done in a proportion on both called as weightage. Now using these two data the return on portfolio can be analysed.

Same can be performed for the other portfolio and analyse it's return on portfolio. Now both the portfolios must be compared based on their returns and the portfolio with highest return is considered to be good for investment as it will being more profit to the organization.

But to analyze and make proper decision alone return us nir enough to make this decision. So the risk on both the portfolios must also be compared for which it is needed to find the risk of each portfolio.

Risk is also referred to as standard deviation for a portfolio. To find this, the individual risk and weightage is used which gives the risks associated with each of the portfolios. Nuw, if the risk is compared, then the portfolio with the low risk us considered to be good to invest.

So it has been seen that such portfolio is considered good for investing which has low risk and high return.

If any client has to make decision to choose any one to invest on, the best option is to select the one with low risk and high return. If the data presented of risk and return of portfolios are sorted, for example among the two portfolios A and B, A has high return than B and also has low risk than B. In that case it is very clear that portfolio A is more profitable to invest on.

But this usually does not happens. Usually if a portfolio has high return, it comes with high risk too. Therefore, comparison needs to be done properly among the two portfolios.

For this, the ratio of the return and risk us calculated for both the portfolios which actully helps to determine the reurtn on any portfolio with respect to the risk associated with each portfolio. The portfoli which has highest ratio is finally selected by client to invest.

Using this technique is best for analysing various portfolio and reduce the risk for any investment. This is because this ratio cleary indicated which portfolio has highest return with low risk in comparison to others. Thus it does not only concentrate on return but also the risk associated with it.

Thus, it is the best way to compare different portfolios and should be used by client for deciding where to invest.