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How do we build wealth with low variance?

- A. VINOD KUMAR

MINIMUM VARIANCE IS an investment approach that focuses on reducing fluctuations within a portfolio. To explain its relevance, let us imagine that a person is attempting to cross a river with an average depth of five feet. If certain areas of the river are deeper, relying on the average depth can be misleading and even dangerous. Similarly, in investments, an average return may mask the underlying fluctuations that can impact the overall experience and outcome for investors.

Variance is a measure that captures how much individual data points deviate from the average. In a dataset, a higher variance suggests that numbers are spread over a larger range, indicating more volatility. To illustrate, consider a person travelling to the airport with an estimated travel time of one hour. During peak traffic, the time might increase to 1.5 hours, while during off-times, it may decrease to 45 minutes.

These fluctuations form the average indicate variance. In investing, a portfolio with high variance will experience more dramatic swings in returns, while a portfolio with low variance, but similar average return, will tend to give a relatively smoother experience.