Expense Ratios & Standard Deviations

Expense Ratios and Standard Deviations - Why They're Important in Optimizing a Portfolio

An unavoidable evil of investing is fees, but they are not something you need to pay too much of. Many people do not pay attention to fees, but they do not realize that they can add up and eat into their returns over the long run.

There are several ways to reduce investment fees and optimize your portfolio. When optimizing a portfolio, we look at a risk management technique called portfolio diversification. In contrast with putting "all your eggs in one basket," you will concentrate on investing in various stocks, asset classes, or sectors. The main aim is to have the positive performance of one asset cancel the other asset's negative performance.

Risk and Returns

There are two aspects to any investment, namely risk and return. Investors will always look for the lowest possible risk to get the highest possible return. The normal distribution measures these two aspects by the standard deviation for risk and the mean for returns.

• Mean or expected value: A share price's particular mean change can be 1.5% daily, meaning that it goes up by 1.5% on average. This expected value, or mean value, signifies return by calculating the average on a large enough dataset and containing historical price changes daily for the individual stock. In short, the higher the mean, the better.

• Standard deviation: An indication of the amount that values deviate on average from the mean. The investment will be riskier the higher the standard deviation, as it leads to more uncertainty.

Expense Ratios

Expense ratios are the percentages of your investment that get used to paying an investment fund annually – it is your cost. The investment fund makes use of the payment to cover the operating costs that it undertakes.

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