Standard Deviation- Meaning, Explanation, Formula & Example

For investors, knowing how to measure and control risk is the key to attaining financial objectives. One tool investors can use is the standard deviation, showing how far apart mutual fund returns are from their average. Standard deviation is one of the key fundamental risk measures that analysts, portfolio managers, and advisors use. Investment firms report the standard deviation of their mutual funds and other products. A large dispersion shows how much the return on the fund is deviating from the expected normal returns.

Standard Deviation in Mutual Funds: Meaning, Calculation and More Details

Understanding a fund’s return potential as well as its risk metrics can help develop a well-rounded approach. A lumpsum investment calculator can also help you estimate the potential returns on your investments. Considering this along with the standard deviation of a fund can help investors assess the potential risk-reward balance and make a more informed investment decision.

One such way of assessing risks and volatility can be using a statistical tool called standard deviation. A critical ratio frequently used by fund managers the standard deviation can greatly help investors. Let us understand the standard deviation meaning to help you assess risk better.

Indicative returns of 10-12% annually

Take the square root of the 3.67 to find the standard deviation, which is approximately 1.915. Add the square values, then divide the result by N-1 to give the variance. This means that the standard deviation of a sum of random variables. This means that analysts or researchers using standard deviation are comparing many data points, rather than drawing conclusions based on only analyzing single points of data, which leads to a higher degree of accuracy.

1. Generally, it is calculated using trailing monthly total returns for 3, 5 or 10 years.
2. Basically, the more spread out the data, the greater the difference is from the norm.
3. The wider the curve, the larger a data set’s standard deviation from the mean.
4. It takes the volatility (price risk) of a security or fund portfolio and compares its risk-adjusted performance to a benchmark index.
5. This metric can be incredibly useful for investors when aligning a fund’s risk profile with their own risk tolerance and investment objectives.

Does standard deviation alone provide a complete picture of a mutual fund’s risk?

Hence we are rewarding the fund for its good behaviour or less volatile behaviour. Likewise, while beta gives us a perspective of the relative riskiness of an asset, it does not give us the absolute or the inherent risk of the asset itself. To sum up, a high Alpha, a high Sharpe Ratio, and a high Sortino indicate better potential performance for a fund. Similarly, a low Beta and a low standard deviation indicate lower volatility for the fund. And a higher R-Squared indicates a better correlation with the benchmark.

What Is Standard Deviation in Investing?

The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investors should consider engaging a qualified financial professional to determine a suitable investment strategy. Alpha is a measure of an investment’s performance on a risk-adjusted basis. It takes the volatility (price risk) of a security or fund portfolio and compares its risk-adjusted performance to a benchmark index.

Well, that is true, but we need to make a few small changes to that equation and include our newly introduced friend, beta. To understand alpha, we need to understand the concept of ‘Risk-free’ return. The risk-free return is the maximum return you can generate without taking any risk. By risk I mean – market risk, credit risk, interest rate risk, and unsystematic risk. One of the key attributes of the mutual fund is the what is standard deviation in mutual fund ‘beta’ of the fund. The beta of a mutual fund is the measure of relative risk, expressed as number; Beta can take any value above or below zero.

This metric can be incredibly useful for investors when aligning a fund’s risk profile with their own risk tolerance and investment objectives. Standard deviation is an essential measure for mutual fund investors. It gives insights into volatility and the risk level of a fund’s return. Understanding the standard deviation helps investors make better, more rational choices as it ensures their portfolios are in sync with the risks for their investment plans. While it is a useful tool for assessing risk and comparing funds, it is essential to consider its limitations and use it with other measures for a comprehensive investment strategy.