portfolio variance
Portfolio Variance is a way of measuring how much your total investments swing up and down together, more than each one on its own.
In plain English
It is a Sunday afternoon at a family meeting in Surulere, and everyone is arguing about how the family should split its savings between the transport business, the small block of shops, and the money kept with a cooperative.
Uncle Femi wants everything in the transport business because it has given the best returns the past two years. Auntie Bisi says that is exactly the problem. If fuel prices rise or there is a strike, the transport money and even the shop rents could fall at the same time, because both depend on people moving around Lagos to buy and sell.
That is what portfolio variance is really about. It is more than asking how risky each investment is by itself, it is asking how risky the whole mixture becomes when you consider how the pieces move in relation to each other. Two calm investments can still make a jumpy portfolio if they tend to fall together on bad days.
A Nigerian in London sending money home understands this instinctively. She keeps some savings in a UK pension fund, some in Nigerian treasury bills, and some in a small property investment back home. If the naira weakens at the same time UK markets dip, her whole portfolio suffers together, even though each part looked fine on its own when she checked it separately last month.
This is why professional investors do more than add up the riskiness of each holding. They study how the holdings move together, called correlation, and use that to calculate portfolio variance. A mix of investments that do not move in step usually gives a smoother ride than one where everything rises and falls on the same news.
Say a Nigerian investor puts ₦2,000,000 in bank shares and ₦2,000,000 in an oil and gas stock. If both tend to fall whenever the central bank raises interest rates, the portfolio variance is high, because a single event can hit both at once. If instead the second ₦2,000,000 went into a tax exempt bond that barely reacts to interest rate news, the portfolio variance drops, even though the total amount invested is the same.
Questions people ask
Is portfolio variance the same as the riskiness of one stock?
No. A single stock's riskiness looks at how much that one investment swings on its own. Portfolio variance looks at the whole basket together, including how the investments move in relation to one another, which is often more important than any single stock's behaviour.
Can I reduce portfolio variance without reducing my expected returns much?
Often yes, by choosing investments that do not move in the same direction at the same time. This is the whole idea behind diversification. You are more than holding many things, you are holding things that react differently to the same events.
Do I need to calculate portfolio variance myself?
Most everyday investors do not sit with a calculator, but fund managers and financial advisers do this constantly. What you can do without maths is ask a simple question before adding a new investment, does this tend to rise and fall with what I already own, or does it move differently.
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