Subject 1. A Portfolio Perspective on Investing

Why should investors take a portfolio approach instead of investing in individual stocks? Why put all your eggs in one basket?

Portfolio theory is used to maximize an investment's expected rate of return for a given level of risk or minimize the level of risk for a given expected rate of return.

For the purpose of investing, risk is defined as the variation of the return from what was expected (volatility). It is represented by a measure such as standard deviation.

Diversification is used to reduce a portfolio's overall volatility. Building a portfolio out of many unrelated (uncorrelated) investments minimizes total volatility (risk). The idea is that most assets will provide a return similar to their expected return and will offset those in the portfolio that perform poorly. The diversification ratio is the ratio of the standard deviation of an equally weighted portfolio to the standard deviation of a randomly selected security.

  • The composition of a portfolio matters a great deal. Different portfolios have different risk-return trade-offs.
  • Portfolio diversification does not necessarily provide the same level of risk reduction during times of severe market turmoil as it does when the economy and markets are operating normally.
  • The modern portfolio theory says that the value of an additional security to a portfolio ought to be measured along with its relationship to all of the other securities in the portfolio.

User Contributed Comments 5

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fsammari: well summarized , i have a question though; how do you guys recommend to study for the CFA , i m doing a reading from each subject. Do you recommend doing the same thing or do a subject at a time meaning finish ethics then go to quantative ....
johntan1979: There are no shortcuts, if that's what you're asking. Read everything, chronologically to make sense of each Study Session. No point jumping around and get confused.
jonan203: i'm probably going to do ethics last since it is easier, for me at least, to retain the formulas and financial theories than the ethics portion.

do what works for you, by this age you should know how you which study methods allow you to retain information the best, at least i hope.
schweitzdm: Someone who passed all 3 levels their first try, told me to try and review the Ethics section four different times before each exam. For your reference, personally I am taking L1 for the first time in December.
ankurwa10: Look, do what's best for you.

For example, i use analystenotes, along with studying each session, because it offers question and short summaries of every LOS, topic wise. and keep coming back once in a while to this website to revise etc. but for study material, for some topics i used CFAI, and some Schweser.

Essentially, don't waste too much time planning (unless you started early coz I sure din't)