But how to measure the risk of a portfolio? There are actually a few different ways to measure the risk.
1. Standard Deviation of Return
This is a measure many investor find hard to understand, but intuitively low standard deviation means low risk. The standard deviation of the large cap US stocks portfolio is 17.31% over the 46-year period, a lot higher than the standard deviation of 10.31% of the 7-asset diversified portfolio.
If we measure the standard deviation of the 37 rolling 10-year periods' annual returns, we would get similar results - the large cap US stocks portfolio had 16.93% standard deviation of the rolling 10-year annual return, versus the 9.75% of the diversified portfolio.
2. Percentage of Time Had Negative Annual Returns
This is a measure easy to accept, no investor likes to lose money in any calendar year. The large cap US stocks portfolio had 20% of time over the 46 years had negative returns, again, a lot higher than the 13% of time the diversified portfolio had negative calendar year returns.
We can also look at the percentage of time had returns less than 10% and less than the return of cash, respectively. The answers are the same - the large cap US stocks portfolio had higher percentage of time with lower than 10% return and lower than cash returns!
3. Three Worst Annual Returns
For many investors who tried to time the market with their investment, a shorter term horizon and the associated return are good metrics to pay attention to. We will look at the worst 3 1-year return during the 46 years for the two portfolios, unfortunately here the large cap US stocks portfolio looks pretty risky: its 3 worst one-year returns were -37% (2008), -26.47% (1974), and -22.10% (2002). The three worst one-year returns for the diversified portfolio were a lot better: -27.61% (2008), -5.51% (2001), and -5.38% (1974).
4. 3-year Maximum Drawdown
This measure looks at the worst-case 3-year return. Of the 44 3-year rolling periods, the large cap US stocks portfolio had a worst 3-year loss of -37.61%, which should be very scary to any investor. As a comparison, the diversified portfolio's worst 3-year return was -13.40%.
The conclusion: a diversified portfolio is less risky than a portfolio consisting of only large-cap U.S. stock.