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Jargon gone crazy

This article originally published in The Northern Daily Leader on 21 June 2014.

I came across a recent article on the BBC’s website which raised the scary prospect of ‘word poverty’. Apparently as humans advance (or regress, depending on your view) we seem to be losing words – our vocabulary is shrinking, despite estimates that a new word is created every 98 minutes. Unfortunately a fair few of those new (and old) words are of the most useless type: technical slang and buzzwords. Some years ago I used to see a doctor who seemed to make it his personal mission to promote buzzwords and technical jargon as often as possible. The common cold became a ‘rhinovirus’, a sprained ankle became a ‘minor soft tissue injury’ and a bruise was always referred to as a ‘contusion’. I usually just nodded blankly and hoped he knew what he was talking about because I sure didn’t.

As you would expect, the world of finance and investing has its fair share of jargon and technical slang. It’s usually trotted out to both confuse and impress and its usage seems to have a direct correlation with your investment management fees (translation: the bigger the words your adviser uses, the higher your annual fees). For all that however, there are one or two words worth remembering when it comes to your investments. These are the phrases ‘standard deviation’ and ‘Sharpe ratio’. Standard deviation is borrowed from statistics and is simply a measure of how spread out a sequence of numbers is from the average of those numbers. For example, take the numbers 10, 20 and 30. The average of these three numbers is 20, as is the average of the numbers 0, 20 and 40. The second set of numbers would have a higher standard deviation however, as there is a greater range between the average of 20 and the low of 0 and the high of 40. The same reasoning applies to investment returns. Would you rather have a portfolio which earned 5% in January, February and March; or a portfolio which earned -5% in January, 20% in February and 1.5% in March? In both cases your final return is the same, but the second example is far more volatile and with a much higher standard deviation (in fact the first example has zero standard deviation as all the numbers are exactly the same). The Sharpe Ratio is simply your portfolio’s (or investment’s) return (less the risk free rate) divided by its standard deviation. So for two portfolios with the same return over a year, the one with the lower standard deviation will have a higher Sharpe Ratio and is the portfolio you should want.

So next time you’re being bamboozled with financial jargon, bamboozle back and ask to know your portfolio’s Sharpe Ratio compared to the alternatives. You may be surprised at what you find.