 |
High Financial Stock Market InvestingOf course, in investing, past returns are not a guarantee of future returns. Therefore, it is better to talk about expected risk and expected return. The risk of an investment is often tied to variables such as variance of past returns, which could be over a year, or shorter or longer, depending into how long into the future your projecting past variance. With increased variance, the models bring with it a chance that the outcome will be highly positive, meaning highly positive return. In stock market, these high variance companies are often operating in areas where there is not much historical operating data, and thus the profitability and thus valuations (via P/E and other metrics) might change radically from year to year. However, if you diversify your holding in these high variance companies, a theory called Modern Portfolio Theory has shown that you can achieve the same level of return with decreased levels of risk. With diversification, you decrease the level of risk associated with individual companies, leaving only market based risk when a certain level of diversification is achieved. The theory was pioneered by Harry Markowitz in his paper "Portfolio Selection," published in 1952 by the Journal of Finance.
|