The purpose of financial planning is to invest in various financial instruments based on your goals, targets, and time horizon. Comparison of investment options within the same category is necessary when selecting investment options. An effective method of doing this is to look at the Risk Adjusted Return. In addition to tracking your investments, you can also use it to see how well they have performed.

Risk Adjusted Returns are calculated based on the risks you take to earn profit and the potential profits. The risk adjusted return will be calculated using a benchmark, most likely a government bond since government bonds are considered to be risk free.

How to Calculate Risk Adjusted Return?

Risk-adjusted return compares the profit you’ve made with the amount of risk you took. The lowest threat investment will have the highest risk adjusted return when compared to two similar investments over time.

Listed below are the variables that can be used to measure risk adjusted return, each of them provides information specifically related to risk –

Alpha –

An investment’s alpha is determined by benchmarking it against an index such as SENSEX or NIFTY. To find out how well the fund performs versus the benchmark or to find out how well the fund or portfolio manager is doing, this will be helpful.

Beta –

An investment fund’s beta is an indicator of its volatility, or systematic risk, and shows the amount of risk associated with it when compared to the market as a whole. Beta value greater than 1 indicates greater market volatility compared to the fund.

Standard Deviation –

Essentially, this measures how much a given asset’s returns differ from its average return over a specific period.  The stability of an asset’s return is measured with this metric.

R-Squared –

It is used to determine the correlation between a portfolio’s price trends and its benchmark. The results of the study are expressed as percentages ranging from 1 to 100, and the higher the number, the more aligned your portfolio is with the benchmark. Performance is measured by Alpha, while movement is measured by R-Squared.

 Sharpe Ratio –

It measures the return you’ll get in relation to the risk you’re willing to take. To calculate risk-free returns it subtracts the return for your asset from the return for a similar asset that is completely risk free, like a government security. It is divided by the asset’s standard deviation, leading to a ratio. An increased ratio indicates that you are being rewarded for the risks you took.

Why considering risk while investing is important?

When investing, you need to consider risk for the following reasons:

• Fund management can be accessed in a logical and objective manner. A skilled fund manager prefers to minimize risk while delivering a high return on investment.
• Making an informed decision based on the funds you wish to invest is much easier with this tool. Consider assets and funds with a low risk appetite and high returns.

Whether you think of risk as a good or a bad thing depends on your perspective. A fund with higher risk may provide you with good returns if you take the risk and invest. Although they may appear less risky, funds with low returns may not generate value for a long period of time. Making an informed decision requires comprehensive evaluation. Build your portfolio by relying on data and research.

Do you want to make smart, informed, and rational financial decisions? Is it hard to find enough time to evaluate and track investments? Contact our award-winning advisors, who stay current with market trends to ensure that you aren’t left behind.