Stock contribution to portfolio risk and return

Stock Contribution Portfolio Risk and Return

Over the last several years, many investors have been shell shocked by the dizzying highs of the markets, followed by the brutal collapse. As a result, this has caused many to begin rethinking the traditional ways of investing. Where, investors are now looking at risks and rewards in different light than the use to. This is because of the extreme amounts of volatility that have been occurring in the stock market. Evidence of this can be seen by comparing the depth of the recent bear market from 2007 to 2009 with that of others (where stock prices would decline nearly 50%). This is tied for second place, as one of the deepest bear markets the United States has ever experienced. Only the bear market from 1929 to 1933 was deeper, while the bear market from 1937 to 1938, tied with recent contraction for second place. ("How Far Have We Fallen," 2009) This is significant, because it shows that when these kinds of market implosions occur, investors can change how they evaluate risks and rewards. To fully understand this, requires examining how much a stock will contribute to the risk of the portfolio and how much to the total return that it adds. Together, these different elements will provide the greatest insights as to the underlying effect that these factors will have on investor sentiment. ("Diversification," 2010)

How much does a stock contribute to the risk of a portfolio?

The degree that stocks will increase the risk to your portfolio, will depend upon if you are practicing diversification and the type of equity securities that you are buying. Diversification is when you are spreading out the underlying amounts of risk, by buying stocks that are in different industries and sectors. The idea is by purchasing these companies and holding them over long-term, you can be able to reduce the volatility along with risk to the portfolio.

At the same time, the type of equity securities that are being purchased will play a role in determining the risks to the portfolio as well. This is because there are various stocks that can be purchased, which could increase or reduce the underlying amounts of risk. For example, an income stock that has a history of paying consistent dividends would have less risk than a growth stock that pays no dividends. This is significant, because it shows how the underlying amounts of risk will depend upon the stock that is being purchased and if diversification is being used. That being said, the overall risks to the portfolio will vary, depending upon the type of stock that is purchased and how much diversification is being utilized. ("What are the Main Types of Stock.," 2010)

How much does a stock contribute to the return of a portfolio?

Historically the average return of the S&P 500 has been 9.8% a year. (Swedroe, 2009) However, the overall impact of the return will depend upon: the underlying amounts of growth and dividends that are received. These two factors are important, because they can cause the total return of the portfolio to vary. As a result, the overall contribution of stocks, on the return of the portfolio; will depend upon the type of equity securities that are being purchased and the holding period.