Portfolio Management & Wealth Planning

Expected return, risk (standard deviation/variance), and correlation (or covariance) with other asset classes. These inputs drive diversification and the efficient frontier.

Equities have the highest expected return and risk; bonds are intermediate; cash/T-bills have the lowest return and risk. Lower correlation across classes improves diversification.

A risk-averse investor prefers less risk to more for a given expected return and requires higher expected return to take on more risk. Most investors are assumed risk-averse.

A risk-neutral investor cares only about expected return and ignores risk. A risk-seeking (risk-loving) investor prefers more risk and may accept lower expected return for the chance of higher payoffs.

U = E(R) − 0.5·A·σ², where U is utility, E(R) expected return, A the risk-aversion coefficient, and σ² variance. Higher A means more risk aversion.