Portfolio Theory and the Capital Asset Pricing Model (Capm) Are Essential Tools for Portfolio Managers and Other Stock Market Investors’
‘Portfolio theory and the capital asset pricing model (CAPM) are essential tools for portfolio managers and other stock market investors’
In order to be successful, an investor must understand and be comfortable with taking risks. Creating wealth is the object of making investments, and risk is the energy that in the long run drives investment returns.
PORTFOLIO THEORY
Modern portfolio theory has one, and really only one, central theme: “In constructing their portfolios investors need to look at the expected return of each investment in relation to the impact that it has on the risk of the overall portfolio”. The practical message of portfolio theory is that sizing an investment is best understood as an exercise in balancing its expected return against its contribution to portfolio risk- In an optimal portfolio this ratio between expected return and the marginal contribution to portfolio risk of the next pound invested should be the same for all assets in the portfolio
Unfortunately, many investors are not aware that such insights of modern portfolio theory have direct application to their decisions. Too often modern portfolio theory is seen as a topic for academia, rather than for use in real-world decisions. For example, consider a common situation: When clients of a firm decide to sell or take public a business that they have built and in which they have a substantial equity stake, they receive very substantial sums of money. Almost always they will deposit the newly liquid wealth in a money market account while they try to decide how to start investing. In some cases, such deposits stay invested in cash for a substantial period of time. Often investors do not understand and are not comfortable taking investment risks with which they are not familiar. Portfolio theory is very relevant in this situation and typically suggests that the investor should create a balanced portfolio with some exposure to public market securities (both domestic and global asset
In order to be successful, an investor must understand and be comfortable with taking risks. Creating wealth is the object of making investments, and risk is the energy that in the long run drives investment returns.
PORTFOLIO THEORY
Modern portfolio theory has one, and really only one, central theme: “In constructing their portfolios investors need to look at the expected return of each investment in relation to the impact that it has on the risk of the overall portfolio”. The practical message of portfolio theory is that sizing an investment is best understood as an exercise in balancing its expected return against its contribution to portfolio risk- In an optimal portfolio this ratio between expected return and the marginal contribution to portfolio risk of the next pound invested should be the same for all assets in the portfolio
Unfortunately, many investors are not aware that such insights of modern portfolio theory have direct application to their decisions. Too often modern portfolio theory is seen as a topic for academia, rather than for use in real-world decisions. For example, consider a common situation: When clients of a firm decide to sell or take public a business that they have built and in which they have a substantial equity stake, they receive very substantial sums of money. Almost always they will deposit the newly liquid wealth in a money market account while they try to decide how to start investing. In some cases, such deposits stay invested in cash for a substantial period of time. Often investors do not understand and are not comfortable taking investment risks with which they are not familiar. Portfolio theory is very relevant in this situation and typically suggests that the investor should create a balanced portfolio with some exposure to public market securities (both domestic and global asset