How to evaluate your portfolio risk

Risk is an integral part of your investment. The importance of this can be better realised in the current times when portfolios are in deep red. Risk assessment of various asset classes helps us to make an appropriate decision while, picking up the security of an asset class.

In investing, there are various ways in which you can quantify the risk, with the most common measurements being standard deviation, Sharpe ratio and beta. In each of these cases, risk measures quantify the uncertainty of an investment outcome over a specific time period.

Standard deviation

One of the most conventional ways of measuring the risk of a portfolio is its standard deviation. It refers to the extent to which your portfolio can go up or down. This measure provides valuable insight if your goal is to look at investment return volatility. For example, the standard deviation of Sensex’s daily return is 1.5 per cent, which comes out to be 25.3 per cent annually. This means that you can expect a fall or rise in Sensex in a year.

Value-at-risk (VAR)

Value-at-risk is one of the latest risks metric, which is used to determine the potential of an extreme loss in the value of your portfolio, in a particular time period with a given level of confidence. Typically, confidence intervals are set at either one per cent or five per cent probability, which are in turn, called 99 per cent or 95 per cent VaR, respectively.

Beta

It is one of the best-known risk measures of a portfolio. It measures the volatility of an investment relative to the market as a whole. It is expressed as a positive integer. A beta of one means your portfolio moves in tandem with the market, such as Nifty or Sensex. Any number above one indicates that your portfolio has greater volatility than the overall market and less than one, means it is less volatile.

Risk measures of a portfolio, as discussed above, helps an investor to align his portfolio in accordance with his financial objectives or goals.