Being able to measure and quantify risk/return is a top priority when trying to evaluate investment portfolios. There are a lot of sophisticated tools that can help investors evaluate risk-adjusted portfolio performance. These tools are also useful to compare investment strategies, indices, or even the historical performance of different money managers and hedge funds.

Combining Risk and Return into a Single Comparable Value

There are two main investing goals: (i) get the highest annual payout (Return), by (ii) minimize the chances of losing money (Risk). By combing risk and return into a single value, investors can compare the real performance of different portfolios. This combination is called risk-adjusted portfolio performance. This analysis includes the following risk-adjusted portfolio performance ratios:

(1) Sharpe Ratio

(2) Sortino Ratio

(3) Treynor Measure or Traynor Ratio

(4) Jensen Measure or Jensen Alpha

(5) Calmar Ratio

(6) MAR Ratio

(7) Omega Ratio

(8) Information Ratio or Appraisal Ratio

(-) Key Points of the Analysis

Three Key Investment Concepts Before Moving On

Before moving on with the ratios that measure risk-adjusted performance, it is important to mention some basic concepts. These concepts include the risk-free rate of return, the standard deviation (SD), and the maximum drawdown. Most of the following performance ratios are partially based on these three important components.

(i) The Risk-Free Rate of Return

The risk-free rate refers to the annual return an investor can earn without taking any risk. Generally, the risk-free rate of return is based on the annualized interest paid on a 3-month Treasury bill. Any investment that is expected to offer lower returns than the risk-free rate of return is an unacceptable investment.

• You can use the annualized return of the 3-month US Treasury Bill in the US or the 3-month Euribor in the EU

Read more: Risk-Adjusted Portfolio Performance Ratios

The US government issues Treasury Inflation-Protected Securities (TIPS) to offer protection against inflation. The principal value of TIPS rises as Consumer Price Index (CPI) rises.

TIPS (Treasury Inflation-Protected Securities)

First issued by the U.S. Treasury in 1997, TIPS are fixed income securities that (as bonds) receive interest payments on the face value. The interest payment is adjusted to cover Consumer Price Index (CPI), plus to offer a minor extra return.

Read more: TIPS and How to Use them for Predicting Interest Rates

Being able to grow your life's savings through investment is important. Over the past century, the US stock market has offered the greatest returns, outperforming the housing market and other types of financial securities. These are some important tips for every investor.

1. The Investing Triangle

Investing is a triangle formed by three axes: (i) return, (II) risk, and (iii) time.

Whenever you push one of the three axes, the other two will expand. This means that in any investment:

• If you wish to have high returns, the risk becomes higher and the timeframe needed to achieve these returns becomes larger
• If you wish to have high returns in a short period, you will have to deal with huge risks
• Never trust someone promising high returns and low risk in short time frames

Read more: Investing Tips & Advice

INTRODUCTION TO FUNDAMENTAL ANALYSIS

Fundamental analysis is a commonly used method for measuring the intrinsic value of a financial-traded asset based on the observation of economic and other 'hard' data.

1. Learn the Basics of Fundamental Analysis

Investment Analysis Framework

There are two forces forming an overall framework of investment analysis:

(i) Technical Analysis, and

(ii) Fundamental Analysis

The Goals of Fundamental Analysis

The main goals of fundamental analysis are:

(a) to identify the fair market value of a financial-traded security

(b) to identify and measure the impact of risks associated with an investment decision (risk identification is essential for managing your portfolio in an efficient way)

Fundamental Analysis Framework

A fundamental analysis framework consists of all major internal and external factors that can affect the future cash-flows of your investment.

(1) Internal fundamental factors

(2) External factors (business, macroeconomic, etc.)

Analyzing Economic & Business Cycles

What are Economic Cycles?

In general, economic cycles are the time periods between growth (economic expansion) and recession (economic contraction). The duration of each economic cycle is determined by key macroeconomic factors such as GDP growth, National Income, Inflation, Consumption, and last but not least, the level of Employment. The debt cycle is the key to each economic cycle.

The Role of Central Banks to the Duration of each Economic Cycle

What matters the most for a central bank is to have high employment and sustainable growth by controlling inflation.

Read more: Economic & Business Cycles

Treasury Bills (T-Bills) and their Correlation with Equity and Forex Markets

All investors must keep a close eye to what happens in the bonds market. Significant changes in the pricing of government and/or corporate bonds can be used as an indicator of upcoming economic transitions. In this context, significant changes in the yield of government bonds or changes in the spread between different-maturity bonds may forecast what is about to happen in the real economy, in the equity markets, and in the Forex markets. Actually, there is an important factor linking every financial market and that factor is the level of interest rates.

Government Bonds Classification

Government bonds, in general, are classified according to their maturity. There are three (3) main categories:

■ Bills –Maturing in less than one year

■ Notes –Maturity in 1 to 10 years

■ Bonds -Maturing in 10 years, or more

The marketable securities are issued as Treasury Bonds. Based on the length of their maturity they are called Treasury Bonds, Treasury Notes or Treasury bills (T-bills).

Read more: Treasury Bills (T-Bills)