Examining My Dividend Portfolio Volatility Using RiskGrades

Ever log into to Quicken, Microsoft Money, or your Excel spreadsheet to see that your portfolio has dropped 5% or even more in one day? This has everything to do with the volatility of the assets you hold in your account. Volatility is a statistical measurement (don’t get scared) of how much an asset’s value can change over time. If a stock such as Company A is said to have higher volatility than Company B, then this means that Company A’s stock price can vary more dramatically over time than Company B can. This is exactly what investors refer to as risk when examining a stock or portfolio. The most common method for placing a value on risk is through either standard deviation or beta. Another way is to use an online service called RiskGrades. I ran my own portfolio through RiskGrades and found some interesting things about it. Before I get into that I want to talk about what RiskGrades is and how it works.

What is RiskGrades

As mentioned, risk is most commonly measured as standard deviation. Standard deviation is the measure of the dispersion of a set of data from its mean. The more spread apart the data is, the higher the deviation – think about it like a scatter plot with the red line down the middle representing the mean and all the blue dots being the different share prices for a stock. The difference between the blue dots and the red line is the standard deviation:

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Standard deviation can be an overwhelming concept to many people, me included and I have taken a a couple statistics courses. RiskGrades attempts to make the standard deviation concept more “user friendly” for investors by providing an intuitive reference point.

So exactly what is a RiskGrade? Here is an except from their website:

RiskGrade is a new statistic, a measure of return variability recently devised by RiskMetrics to help investors better understand their market risk. RiskGrades are scaled from 0 to values exceeding 1000, where 100 corresponds to the average RiskGrade of a diversified (market-cap weighted) index of international equities during normal market conditions. You would expect cash to have a RiskGrade of 0, while a technology IPO may have a RiskGrade closer to 1000. RiskGrades are dynamic — changing over time to accurately reflect market conditions, allowing for comparisons in an intuitive fashion, and capturing currency risk

So essentially it is a way to compare an asset or portfolio to a predefined reference point that represents the risk of the overall market. As we know from our index fund discussions, the risk we take as investors is whether we match the market returns or not. RiskGrades helps us measure this. That should be enough information for now – if you want to further understand RiskGrades and its metholdolgies then you can read a document they put out here (pdf).

The Dividend Guy’s RiskGrades Measure

I entered my portfolio into the RiskGrades tool and got an associated risk measure. One thing to note is that the tool did not allow me to enter my pension fund holdings. This is an important issue with the RiskGrades tool as many investors have large portions of their portfolios in pension funds and without being able to incorporate this the tool has limited value. So, in the interest of this excersise I chose to input an index fund that represents my holdings in my pension fund. Since my employer picks up all fees for the funds, MER’s included, I think this is allowable. I know this is not perfect but it is all I could think of to make this work!

The risk grade that I received after entering the assets I could enter was 86. This means that my portfolio is less risky than a diversified (market-cap weighted) index of international equities during normal market conditions. In addition, if we look at RiskGrade Suitability Scale they have developed then I am somewhere between Growth and Aggressive.

The fact that I have no bond or fixed income exposure right now is the main reason I do not have a lower RiskGrade and therefore am place further to the left of the scale. Having no fixed income exposure is considered aggressive in the investment world and this scale reflects that.

What to Do With This Information

In my opinion, the best way to use the information obtained with RiskGrades is to see the impact each of your holdings has on your potential returns. If a RiskGrade is way out of whack, then you need to assess its place in your portfolio.

In addition, keeping your RiskGrade in line with your chosen asset allocation is also important to do. Check your grade in reference to the RiskGrade Suitability Scale. If you are focused on being aggressive then your RiskGrade should reflect that. If you are conservative then you should also show that. Overall, RiskGrades is just a tool. The most important thing is to identify an appropriate asset allocation and stick with it through thick and thin.

Note: This is not an endorsement of the RiskGrades product. It is one way of measuring the risk of an asset or portfolio.

(Photo Credit: sanja gjenero)

• Choosing Fixed Income Assets to Meet my Target Allocation
• The 9 Rules of Risk Management
• Day 4: The Dividend Key – High Dividend Stocks and the Risk and Reward Balance
• The Dividend Guy Investment Process Part 9: My Benchmark
• Small-Cap Investment Choices for a Dividend Portfolio