Page 146 - A Canuck's Guide to Financial Literacy 2020

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Return on Portfolio with Two Assets: You have invested $3,000 in Pepsi stock and
$2,000 in Coca Cola. the expected return on Pepsi is 4.5% and the expected return on
Coca Cola is 5.5%. What is the return of your total portfolio?

First, you’ll notice that Pepsi makes 60% of your total portfolio while Coca Cola makes up
40%. Multiply the weight of the portfolio by the rate of return.

(0.60)*(4.5%)+(0.40)*(5.5%) = 4.9%

You may not have only two holdings in your portfolio. You may have 10+ holdings. By
multiplying the weight of each asset class by the expected rate of return, you’ll find the
expected rate of return of the total portfolio.

Standard Deviation

Standard deviation is the statistical measure of risk or uncertainty that measures the various
possible returns. The larger the standard deviation, the great dispersion of expected returns
and the greater the risk or uncertainty.

Standard deviation is also often referred to as total risk, which includes both market risk
and specific business risk. For example, if we have two portfolios, Portfolio A and Portfolio
B, each with a expected return of 10% but with different standard deviations, which portfolio
would you choose?

Portfolio A is safer than B as it can provide you with a range of return of 2% to 18%.
Portfolio B is riskier as you have the chance to lose money, hence – the higher the risk, the
higher the expected return.