See: Treynor Index.
We all wanna get the most bang for our buck, especially when it comes to our portfolios. Risk is necessary for the chance at having great returns, but it doesn’t guarantee them.
The Treynor ratio, a.k.a. the reward-to-volatility ratio, measures your portfolio performance in terms of how much return you’ve gotten per unit of risk taken.
We can thank American economist Jack Treynor for this one. He also helped to create the Capital Asset Pricing Model (CAPM)...so he’s a bfd.
Ideally, you’d be seeing excess returns per unit of risk. But how do you measure risk? Risk in the Treynor ratio uses a portfolio’s beta, which is basically a best-fit regression line of market returns to individual returns...a standard measure of volatility in technical portfolio analysis. The Treynor ratio is simple, but effective: subtract your risk-free rate from your portfolio return, and divide that number by your portfolio’s beta. Beta-bing, beta-boom: you’ve got a risk-adjustment measurement of your returns. The higher the ratio, the better.
Related or Semi-related Video
Finance: How Are Risks and Rewards Relat...589 Views
Finance a la shmoop how are risk and reward related? or
interrelated okay so here's an illustration of risk you're in a golf [golfball near a golf hole]
tournament on the first tee of a hole with a narrow fairway if you take just a
half swing your ball won't go very far but you also likely won't end up here [golfer gives a half swing and ball goes towards the hole]
it'll almost certainly fit nicely in the fairway and it's likely you'll need
three or four half swing strokes to reach the green if you're cool with [golfer taking multiple shots and reaches the green]
shooting 28 over par or a hundred today well then maybe these half
swings are your ticket to happiness sometimes a score of a hundred wins the [golfer stood beside a scoreboard with a score of 100]
purple turkey that is you are taking less risk and are totally fine being
rewarded less all right now meet Corey Mcilshmoop he wants the big score
lots of strokes under par and he's willing to risk a lot to get there. His [Corey Mcilshmoop swinging a golf club]
ball either goes 340 yards and lands on the green setting him up for an eagle
putt it goes out of bounds with a vengeance there, ouch.. all right well on
the investing golf course like this one generally speaking riskier investments [golf course made into an investment course]
are things that don't have a long track record of success like compare the
coca-cola company with a new IPO of whatever.com what are the odds that in [a comparison of coca cola vs. whatever.com]
five years people are still drinking sugared fizzy water well pretty good
right now how about the odds of a billion people still being enamored of [myspace and whatever.com with number of people liking the website rising]
whatever com yeah much less clear like less clear than crystal pepsi.. Risky can
also mean private investments in two kids plugging away inside of a garage [Kids working on a project in a garage on laptops]
and yeah they could be Larry and Sergey making Google but more likely they could
be buzz and billy-bob making a whoopee cushion that pushes the bounds of
realism yeah..risky can also be just a company that doesn't pay a dividend if a
company does pay a divy, you at least get the dividend back each year as you slowly get your
initial investment returned to you you can make money even if the stock price [company's share price, dividend and yield]
doesn't go up in the case where stock pays no dividend your instead betting [person puts chips onto a roulette table]
everything that the company will just grow but growth companies with no
dividend while that's all well and good think things
like Facebook and Amazon and uber but if the company doesn't grow well then bad [whatever.com falling on the floor]
things happen you've got no dividend and the share prices declined and so the
basic idea is that the more risk you take the more reward you can have in the [man playing golf and eagle swoops and picks up ball]
same lack of reward you can have as well and every now and then you get one of
the three hundred forty yard drive to go in the hole which makes the risk totally [money falling next to a building of baby's first chainsaw]
worth it yeah because well you're never going to sit around telling your
grandkids about the time you shanked your drive 15 yards [grandad telling children a story about golf]
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