|By Nathan Young|
June 1, 2017
When you look at a fund or investment, many people focus on the potential gains and what they might receive, but they may fail to realize that there is a potential downside or expected shortfall.
The expected shortfall is a sensitive way of figuring out the risk of a portfolio against the benchmark. Essentially, it is focusing on the worst outcomes and gives you a number of what would happen to the position does not pan out accordingly.
When you look at an investment, the first aspect and most enticing is the potential profits you may gain by investing in the position. This is the most enjoyable aspect but is equally important because you want to know what you are expecting in return. You wouldn’t lend your money without knowing what you’re getting in return and investing is no different.
The second aspect is the potential losses, which is equally or more important than the profits because you need to know how much loss you can take before you need to exit your position. Losses need to be considered and used to set a stop loss, or a point where you will leave the position no matter what.
Lastly, is the risk associated with the position, and this is where expected shortfalls can come in handy. Risk is something you want to keep low while gaining as much exposure as desired to generate the returns necessary for you to invest. Risk can be all over the board for different people and should be watched closely.
Expected shortfall will certainly help you in this area of investing and should be used in your research. Of course there are the articles and opinions out there for whatever you are investing in, but that doesn’t necessarily help you. With all of that being said, test it out for yourself and see if it is something you want to implement in the future. If you get stuck or need help, join an investing community and bounce ideas off of people for real time feedback. At the very least you will have the knowledge on hand to use in the future if need be.