Mean-Variance Analysis
Candlefocus EditorThe expected returns of securities can be derived from their past performance and historical trends. The measure of risk (or volatility) is determined from the standard deviation of returns over some period of time. When mean-variance analysis is applied, an optimal portfolio can be formed. This portfolio is composed of the assets that provide the highest return with the least amount of risk. For instance, if an investor has a goal of achieving a 9% return, but wants to minimize the risk of doing so, a portfolio of various assets can be formed that provides a higher expected return than 9% with a much lower risk.
The behavior of the underlying asset (i.e. stocks, bonds, funds, etc.) affects the returns of a portfolio. Therefore, the selection of the specific asset class and individual securities must also be made with careful consideration. Mean-variance analysis helps an investor make decisions by calculating the expected return and risk of the individual assets within a portfolio, as well as providing a means for portfolio optimization.
Overall, mean-variance analysis is a powerful tool for investors, as the process is designed to help them identify the highest reward with the least amount of risk. When used strategically and ethically, it can prove to be a helpful tool in making informed and successful investment decisions.