Have you ever thought about why diversifying your investment portfolio is crucial? It all comes down to investment risk. In essence, it can effectively reduce the volatility of your portfolio, thereby helping minimize the risk associated with your investments.
Over time, a less volatile and risky portfolio = opportunity for greater compounding, which is a key strategy for long-term portfolio growth.
You might not be familiar with the term “Variance Drag Phantom Tax” (VDPT), but it plays a crucial role in your portfolio’s performance.
To understand VDPT, consider comparing it to a sports player’s statistics, such as those of a basketball or baseball player. These statistics quantitatively illustrate the player’s quality. Similarly, while there are various important metrics for assessing an investment portfolio’s quality, VDPT reflects the risk in relation to your historical rate of return.
Watch today’s video to learn more.
Ed Butowsky created the VDPT statistic after almost two decades in the high-net-worth industry at Morgan Stanley. Ed saw the issue involved with clients taking on too much risk for the return they were getting.
As seen in the video, you can simply find your VDPT by dividing your standard deviation by your historical rate of return.
DEFINITION: Standard Deviation – A measure of how much individual values in a set vary from the mean. It quantifies the level of variability or dispersion in the data. It is often used to gauge the risk or volatility of investments. Simply put, it is like a measure of how much the returns on your investments might bounce around. High standard deviation means more unpredictability, while low standard deviation implies more stability.
Example: Investor A has a historical rate of return of 10% and a Standard Dev. of 16 while Investor B also has return 10% with a Standard Dev. of 8. Please see the below chart to see how this plays out over the course of a decade and note the VDPT in this portfolio.
If you would like to learn more specifically about how we come up with those calculations, you can reach out to me by finding my contact info below.
Our Investment Forensics Toolbox can also be found by clicking here.
To listen to Ed and Jordan discuss VDPT and other important topics on your investment portfolio, visit our podcast website page where you can listen in on the discussion.
VDPT can be a helpful stat to know for an investor of any net worth or level of involvement. It is a clear number that represents the inherit relationship of both risk and return, and can be used to gain a better understanding of your portfolio and potentially plan more accurately into the future.
Jordan McFarland, Investment Advisor
Chapwood Investments, LLC is a SEC Registered Investment Advisory Firm. No mention of a particular security, index, derivative or other instruments in this material constitutes an opinion on suitability of any security. The information and data in this material were obtained from sources deemed reliable. Their accuracy and completeness are not guaranteed. At any given time, principals at Chapwood Investments, LLC may or may not have a financial interest in any or all of the securities or instruments discussed in this material. The guests appearing in material do not receive compensation or provide endorsements or testimonials. Past performance is not indicative of any future results.
Calculators are hypothetical examples used for illustrative purposes and do not represent the performance of any specific investment or product. Rates of return will vary over time, particularly for long-term investments. Investments offering the potential for higher rates of return also involve a higher degree of risk of loss. Actual results will vary. We strongly recommend that you seek the advice of a financial services professional before making any type of investment.