What does variance have to do with Assets
there's something poetic at the end
One of the ways assets are classified is based on their risk. Risk in finance is synonymous with variance.
Variance is a measure of how dispersed a sample is from its mean. The more the divergence, the higher the variance. This translates to the higher the variance, the higher the risk.
Risk is defined as the level of uncertainty. When there is a high uncertainty about the return an asset will provide, it is said to be a high-risk asset. When the uncertainty is low, then it is a low-risk asset.
Since the variance measures risk, it implies that assets that have returns that are widely dispersed are riskier. Investments with less dispersion in their returns are less risky.
The RELATIONSHIP BETWEEN risk and returns is directly proportional.
The higher the risk, the greater the expected return.
Assets are classified into three groups:
Low-Risk Assets
These are assets with considerable low risk. The returns from these assets are also low. However, they provide a more stable source of returns than other asset types. They are mostly fixed assets. Low-risk assets include; bonds, Treasury bills, certificates of deposit and other high-yield savings accounts (HYSA).
Medium-Risk Assets
These are assets that have a bit more risk. They also have higher returns than low-risk assets. There are “not too much, not too small” risks and return assets. An example of such is rental properties. This could include real estate, equipment or machinery for rent, etc. These assets usually provide returns that are somewhat fixed with minimized risks.
High-Risk Asset
These are assets with the highest range of variances. They provide high returns as a compensation for the risks. These assets include stocks, cryptocurrencies, forex, commodities etc.
How do you invest based on these asset types?
For the uninitiated, it is important to diversify-to spread your investments across different asset types, from fixed income to medium and high risk assets. This prevents you from total ruin because you had only all your investments in one basket.
The following factors will affect how much you put in a specific type of asset:
Your time horizon
your risk profile, which is affected by your age, your risk tolerance etc.
Let me leave you with a few words I saw on Instagram.
“What works for them may not work for you.
What worked there may not work here.
And what worked then may not work now.”
And that is why it is called PERSONAL finance.