98) Return vs Risk in Investments

98) Return vs Risk in Unit Trust Investments

In investments, everybody wants to have High Returns and No Risk.
However, in real life investments, it is not possible to have returns without risk.

One idea you can use is to divide the fund's 3 Years Annualized Return by its 3 Years Fund Volatility Factor.  The higher the ratio number, the higher the return per risk.

Please note that this idea is not an official measurement, but something you can use as a guide. Please refer to the Disclaimer page.

Click this link if you want to know more about the my idea of the 4S of investments.

For our discussion, we use 2 funds as comparison.

Fund A: 3 year Annualized return =  8.18%
Fund B: 3 year Annualized return =  8.87%

If you only look at Returns, Fund B has higher return than Fund A.

However, have you considered the Risk factor?


Risk Factor

To have a measurement, we can use the data published in the Unit Trust fund performance reports. The screen shot below is taken from FIMM's article on Fund Volatility Factors and Classification.. The fund's volatility is measured over 3 years period.

FVF = Fund Volatility Factor
FVC = Fund Volatility Classification

You can download the full article published by FIMM (previously known as FMUTM) as published in May 2009. Click on the "Fund Volatility Factors and Classification" title and click on the "Download" button to download the article.

https://www.fimm.com.my/investor/abc-of-unit-trusts/understanding-unit-trusts/




Return Factor

Now we want to measure the feturn of the fund. You can use the fund's Annualised Return as per example shown in Fund A's performance review report.



Fund A's volatility is as shown below.

 

Using the information available of the Fund A, you can just divide the 2 numbers. 

3 Year Annualized Return = 8.18
3 Year Volatility Factor =8.3
So, the Return vs Risk ratio is 8.18/8.3 = 0.9855

Fund B has another set of numbers.

3 Year Annualized Return = 8.87
3 Year Volatility Factor =10.9
So, the Return vs Risk ratio is 8.87/10.9 = 0.8138

From the Return vs Risk Ratio, Fund A is better.
It is because you get higher return per risk you took.

Also note that the Return vs Risk ratios will constantly change over time. You will get different ratios for Fund A and Fund B during different periods.

For Foreign Equity funds, the Volatility Classification is normally Very High.
For Local Equity funds, the Volatility Classification is normally High.
For Balance funds, the Volatility Classification is normally Moderate.
For Bond funds, the Volatility Classification is normally Very Low.
For Money Market funds, the Volatility Classification is normally Very Low.


Therefore, it is also important to know the Return vs Risk. It is important especially if you need to withdraw the money during the volatile market. You definitely don't want to withdraw the investment during the stock market down turn, causing you to lose more money.

When you need to pay for your child's education fees, the University does not care whether the market is up or down.

Do review your total portfolio regularly and understand the reward vs risk. As a caution, do not only rely on the Return vs Risk ratio as the only measurement to decide which funds to invest.

The ratio is based on past performance. Nobody knows what the future performance will be.