IT Portfolio Management Step-by-Step: Unlocking the Business Value of Technology

1.7. VALUE AND RISKS

Investors must have some willingness to commit to a level of uncertainty. For investments that have a low probability of an expected result and a high number of possible outcomes, investors expect to receive a higher rate of return due to the potential volatility (investment A in Exhibit 1.5). In contrast, for investments that have a high probability of an expected result and a low number of possible outcomes, investors expect to receive a lower rate of return due to the increased certainty (investment B in Exhibit 1.5). Triangular or normalized probability distribution curves are used to visually show the range of possible outcomes for investments.

For many investments, there is typically a positive correlation between risk and the variability potential for reward—the higher the risk, the higher the variability in the return (or, conversely, the higher the risk, the lower the probability of obtaining a desired outcome). In 1952, Dr. Harry Markowitz, Nobel Laureate and pioneer of portfolio management, published "Portfolio Selection" in the Journal of Finance,^[] which showed that a diversified portfolio of high- and low-risk investments yields a higher return than a portfolio comprised of solely high-risk investments or a portfolio of only low-risk investments. Dr. Markowitz described a concept called modern portfolio theory—an efficient suite of investments at a defined level of risk that will maximize return. Modern portfolio theory states there is no single ...