Talk:Risk and return

PURPOSE OF ARTICLE
The purpose of this article (page) is to provide an online reference to investment risk and reward as presented in investment textbooks, and supplemented by less academic investment books, especially those written by Boglehead authors (e.g., Bogle, Larimore et al, Swedroe, W. Bernstein, Ferri). The intent is not to promote Boglehead investment philosophy (or anything else), although much of BH investment philosophy is based on standard finance theory, so there should be no conflict.

The intended audience is the investor who is not afraid of some basic math, and who is ready for introductory, investment-textbook-level material. --Kevin M 21:31, 12 April 2012 (CDT)

STYLE
The intended style of the article is Wikipedia style, as opposed to tutorial or book style; e.g., the use of personal pronouns is avoided. The intention is to base everything on credible sources, as defined by Wikipedia policy, and not interject opinions of the wiki article authors. This should minimize debate about the actual content. Obviously contradictory points of views are fine (actually encouraged) as long as they are based on credible sources. --Kevin M 16:10, 2 April 2012 (CDT)

Issues, Corrections, Misunderstandings
There is no reason given for explaining the drop in the 90-day return from 1% to -2%. The concept of Duration needs to be introduced (or at least referenced).

"Figure 2 illustrates the longer-term uncertainty of real returns on 90-day T-Bills. Also, note that the relative certainty of return does not mean that the real return necessarily is positive. It may be known with certainty that a 90-day T-Bill will earn a nominal return of 1% over its 90-day term. However if inflation over the 90-day term is expected to be 3%, the relatively certain expected real return is -2%."

--LadyGeek 15:44, 12 April 2012 (CDT)


 * If you misunderstand it, so might others, so thanks for commenting. Duration has nothing to do with anything if a bill or bond is held to maturity. It only impacts the value before maturity. The assumption here (unstated I guess) is that the bill is held to maturity. The only point is that the real return (inflation adjusted) is different than the nominal return (not inflation adjusted). I guess I'm saying the same thing that Barry says (below) in different words. --Kevin M 21:31, 12 April 2012 (CDT)


 * The duration of a short term T-bill is so short that changes in interest rates have very little influence on the price of the T-bill, and even in those instances where a very large increase in rates would temporarily nudge the price lower, an investor only needs to hold the T-bill for the few days remaining to maturity to receive the entire original principal. What the example clearly states is that the T-bill will provide its nominal return, but if inflation unexpectedly rises during the term of the bill, the real return will be reduced. In other words, an investor purchases a 90 day T-bill yielding a 1% annualized yield. At the time of purchase the inflation rate is 0.5% annualized. The next month, the Labor department announces that inflation has increased to 3.0% annualized; and announces it remains at 3% the following month. The investor in this instance has earned his promised 1% annualized return; but the real return is -2% annualized. --Blbarnitz 16:10, 12 April 2012 (CDT)

Thanks. I did not know the time period that duration was significant. The scenario helped to explain what I missed.


 * It's not the time period that is significant, it's the type of security and whether or not the security is held to maturity. The nominal return of a US treasury bill is certain if held to maturity. The real return is not. Same for a zero-coupon T-Bond, since there is no reinvestment risk. The opportunity cost is another but separate issue (interest rates rise but stuck with current rate until maturity). --Kevin M 21:31, 12 April 2012 (CDT)

To avoid confusion, would it help to show expected return with a more formal notation? E.g. $$E$$xpected return (using the math symbol $$E$$ for clarity)

--LadyGeek 17:03, 12 April 2012 (CDT)


 * This is not a standard convention. I'm using what I consider the best conventions from the three investment textbooks I own. Where in the article do you find it confusing? It is a confusing topic, which is becoming more clear to me as I write about it. In general the term is handled quite loosely in most if not all books. --Kevin M 21:31, 12 April 2012 (CDT)

I didn't find it confusing in your article, but was considering a way to clarify the distinction in my work-in-process article, Risk and return: application. Perhaps it's best left as-is, as it may introduce more problems than it solves.


 * Thanks for clarifying. Distinction between what and what? When discussing historical returns, perhaps stick more with "expected value" of return, or just "mean return". Then when getting into future values, start using term "expected return". Most books, including textbooks, simply gloss over this; I assume they just expect you to understand it from context. Since this is an advanced article, it seems OK to introduce the term earlier, and maybe do a bit more explaining than the typical book --Kevin M 14:53, 13 April 2012 (CDT)

I don't see any definitions of "windfall" risk. dbr mentions this in the forum discussion and I incorporated it into my chart (Figure 2). I don't see it mentioned anywhere on google, perhaps it's just used in context to mean the opposite of shortfall. --LadyGeek 10:40, 13 April 2012 (CDT)


 * I think maybe dbr is just trying to maintain the balanced perspective that uncertainty of return could result in upside as well as downside surprise, which I agree with, except that downside surprise is the one that has a negative impact on reaching investment goal, so it deserves special attention. You don't buy a negative annuity to insure against windfall risk. I have never seen the term used.--Kevin M 14:53, 13 April 2012 (CDT)