1. William Sharpe is a STANCO 25 Professor of Finance, Emeritus at Stanford University and one of the originators of the Capital Asset Pricing Model and Sharpe Ratio, in addition to receiving the 1990 Nobel Prize in Economic Sciences.

Step 3:    Define Your Stock Market Risk

Structuring stock and bond portfolios to take risks worth taking, while protecting against inflation, lends purpose to an investor. Rather than analyzing individual securities, investing becomes a matter of deciding how much to risk in stocks.

In 1964, Nobel Prize winner William Sharpe1 argued stock market risk is the most important determinant of return. Sharpe’s work estimates 70% of a portfolio’s return can be explained by stock market risk.

With the assistance of modern computers, Eugene Fama and Kenneth French expanded Sharpe’s work beyond stock market risk to include exposure to small companies and value companies. This more complete Three-Factor model explained 96% of a portfolio’s return.

Three-Factor Model

Data Source: Dimensional Fund Advisors