Wall Street types have many ways of assessing the risk involved in their investments. One popular way is to draw a capital allocation line (CAL) on a graph (using an Excel program most of the time). The line will show all possible combinations of low-risk assets (such as Treasury notes) and more risky assets (such as stocks). The capital allocation line helps investors decide what combination of low-risk assets vs. more risky assets to invest in.
Using the graph, you can find your personal sweet spot of risk vs. return. The Y-axis is the expected return and the X-axis is the amount of risk, as measured by the standard deviation from the mean. If you pick a preferred risk level, the graph will show you the expected return. Or you can target a return level and see what kind of risk you'll have to stomach.
So let's say trader Calvin wants to determine the best combination of low-risk investments and more risky ones. He has two assets: a Treasury note and a stock of a recent initial public offering (IPO). Calvin expects the Treasury note to return 3% with a risk of (essentially) zero. His analysis shows the stock will return 11%, but the risk factor is much higher than with the Treasury (and higher than Calvin is willing to deal with).
After trying different combinations in the CAL program, Calvin decides that his optimal mix is to invest 30% in the virtually-risk-free Treasury note and 70% in the more risky stock. That gets him a healthy-enough return and a risk level that will allow him to sleep at night.
An example of a capital allocation line can be found at http://breakingdownfinance.com/finance-topics/modern-portfolio-theory/capital-allocation-line/.
Related or Semi-related Video
Finance: What is a Hard Asset?12 Views
Finance allah shmoop What is Ah hard asset Yeah It
takes a lot of hard work to get an asset
like that Okay So hard asset is just one that
you can bang on touch Engage with cell Alright examples
Oil it's Hard asset gold Hard of vintage nineteen Fifty
seven Ferrari with beige leather interior hard four thousand head
of longhorn cattle in texas A commercial building in the
best part of town All of these arm or less
commodities Hard assets Well okay Okay The categories Rare cars
art coins stamps stuff like that that's where they fit
So what do you care if something is ah hard
asset or a soft one Well most or all hard
assets are commodities and they generally do very well in
periods of very high inflation when you know stocks were
getting crushed And yeah the feds raising rates appoint a
quarter now forever Well equities and bonds will get crushed
Commodities well generally keep up with the spike in prices
causing the fed raised rates in the first place So
they're a good hedge for most investment portfolios And not
all of them are great forever like check out riel
Inflation adjusted oil prices the last few decades you had
not a good run Most not all do well though
an oil will likely have its day in the sun
again At some point you lan When in doubt remember
what kim kardashian and warren buffett said A good asset
is hard to find and a hard asset is good
to find But we won't tell you who said which
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