Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio

Chapter 1. In Search of the Upside

It is striking how little most people understood about risk as recently as three decades ago. Risk, of course, is that piece of information all investors need to know—and should desire to keep as low as possible in relation to the returns they expect to see on their investments. Fortunately, developments in modern portfolio theory provide a framework for addressing the ways risk can affect expected returns.^[1] The developments have been nothing short of dramatic.

The Measurement of Risk

We now have the Sharpe ratio at our disposal, a well-known formula useful for evaluating alternative investments and determining when to add additional assets to a portfolio.^[2]

The Sharpe ratio summarizes two measures—mean return ...