Portfolio Risk Metrics
Risk in a portfolio is multidimensional — no single number captures it fully. Standard deviation (volatility): the most commonly used risk measure; quantifies the typical magnitude of return fluctuations around the mean. A 10% annual standard deviation means roughly two-thirds of annual returns will be within ±10% of the mean. Higher volatility = higher uncertainty = more emotional and financial stress for investors. Maximum drawdown (MDD): the largest peak-to-trough decline in portfolio value over a specified period. For the S&P 500: −57% from peak to trough (2007–2009). Maximum drawdown is the risk metric most directly relevant to investor psychology and the ability to stay invested. An investor who cannot endure a 50% decline psychologically (panic selling at the bottom) should not hold a 100% equity portfolio regardless of what mean-variance analysis suggests. Value at Risk (VaR): the maximum loss at a specified confidence level over a specified time period. 95% 1-day VaR = $10,000 means 'with 95% confidence, daily loss will not exceed $10,000.' Conditional Value at Risk (CVaR, Expected Shortfall): the expected loss given that the loss exceeds the VaR threshold — addresses the fat-tail risk that VaR ignores. Calmar Ratio: annualized return / maximum drawdown — measures return per unit of maximum drawdown risk. Higher Calmar = more return for the drawdown experienced.