Standard Deviation Definition Mutual Funds

“The Wall Street Journal” reports that low volatility investments, those with low standard deviations, traditionally perform better over time than their peers. However, a fund that consistently loses money will also have a low standard deviation. Review all your mutual fund’s statistics and measurements to ensure informed decisions. Historical standard deviation is a strong indicator of future performance in a mutual fund.

These outer bands oscillate with the moving average according to changes in price. Every value is expressed as a percentage, making it easier to compare the relative volatility of several mutual funds. I’d suggest you go through that entire chapter to understand the concept of standard deviation and volatility. This will help you not just in your MF investments, but also investments in stocks.

For instance, say you have a low-risk appetite and are considering investing your money. You have two fund options, both of which have an average rate of return of 10%. Fund A has a standard deviation of 6% and Fund B has a deviation of 8%.

Measuring Mutual Fund Risk with Alpha, Beta, R-Squared & Sharpe Ratio

The same fund with a standard deviation of 2 has a return range of 2 to 6 percent. In investing, high standard deviations typically indicate high volatility what is standard deviation in mutual fund — a return that fluctuates often and by large amounts. For starters, the value of standard deviation is calculated using historical data.

Next, take each individual data point and subtract your average to find the difference between reality and the average. Divide the resulting sum by the total number of data points less one — if you have 12 data points, you divide by 11. The point here is that standard deviation is a guiding light but not a stoic statistic on which decisions can be taken.

All you need to know about NPS – National Pension Scheme

Standard deviation is a statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution (a bell-shaped curve). The measurement is used widely by mutual fund advisory services and in modern portfolio theory (MPT). In the case of MPT, past performance of an asset class is used to determine the range of possible future performances and a probability is attached to each performance. The standard deviation of performance can then be calculated for each security and for the portfolio as a whole.

However, do consider other metrics too, along with standard deviation, to correctly assess an asset’s volatility. Remember, investing as per your risk appetite is important when you are investing in market-linked securities so that a rough patch does not cause you immense financial pain. Conversely, an investor that is more risk-averse may not be comfortable with this standard deviation and would want to add in safer investments such as large-cap stocks or mutual funds. In a perfect world, all investment prices would move steadily in an upward direction with little deviation from that nice, smooth path. In reality, investment prices fluctuate — sometimes wildly — with changes in the economy and business environment.

Fund managers and hedge fund managers love to talk about their alpha indicating that they are good enough to outperform the market and deliver above-average returns to their clients. Alpha is quite a significant number when evaluating mutual fund risk. Franklin India Bluechip Fund uses NIFTY 100 TRI as its benchmark. Over a 5-year period, Franklin India Bluechip Fund has delivered a CAGR of 13.92% while the benchmark has delivered 13.54%, which translates to an alpha of 0.38. Alpha (also called the “holy grail of investing”) measures the performance of an investment portfolio against its benchmark index. If Mutual Fund B also has an average annual return of 10% but a standard deviation of 15%, you would expect about 68% of the time for the return to be between -5% and 25%.

The R-squared on these three funds indicate that index funds always tend towards an R-squared of 100 as shown in the data related to HDFC Nifty 50 Index Fund. On the other end, a low R-squared means much lower amount of a portfolio’s movements can be explained by movements in its benchmark index. An R-squared measure of 30 means that only 30% of the portfolio’s movements are aligned to the benchmark index movements. An R-squared of 100 indicates that your portfolio exactly mimics the benchmark index’s movements. By using the formula above, we are also calculating Variance, which is the square of the standard deviation.

What Does Standard Deviation Measure In a Portfolio?

I contend that a higher beta can be a boon in disguise because it works both ways. A stock with a beta of 2 (relative to the index) goes up or down twice as much as the index in a given period of time. That is, it considers two things – one the return of the fund and secondly the fund’s risk. Thus, two funds having the same returns can have different Alphas. By using this website, you understand the information being presented is provided for informational purposes only and agree to our Terms of Service and Privacy Policy.

Although the benchmark on all three funds are different, I don’t see too much of difference here to nullify the comparison and the core objective of this exercise. Investors should clearly understand the different between what alpha and beta aims to explain. However over a 3-year period, Franklin India Bluechip Fund and the NIFTY 100 TRI have delivered 12.76% and 17.41% respectively.

Some investors might be comfortable accepting more volatility if it means potentially higher returns in the long run. Still, you might prefer to know what you’re getting into in terms of standard deviations, rather than getting caught by surprise if returns swing up and down. Understanding standard deviations can help investors make investment decisions that align with their risk tolerance and overall financial circumstances. If the asset has a standard deviation of, say, 5%, then most of the time the returns would be expected to deviate from that 10% average between plus or minus 5%. So, from 10%, you may commonly see 5% to 15% returns as well under the standard deviation. If the standard deviation was 15%, then the asset would be expected to have more volatility, as returns on an asset averaging 10% in this case could also commonly range from -5% to 25%.

How to Find the Risk of Portfolio Volatility

A Sharpe ratio of 1 or more is considered to be a better risk-to-reward proposition for the investor. Also, when comparing two assets versus a common benchmark, the one with a higher Sharpe ratio provides better return for the same risk. Both measures (alpha and beta) need to be used in calculation, comparison and prediction of investment returns. As an investor, it’s important for you to check what benchmark are the fund managers using. Case in point is the Aditya Birla Sun Life Frontline Equity Fund, also a large cap fund, which uses NIFTY 50 TRI as its benchmark.

• Wondering how a smallcase is different from a mutual fund as both are diversified buckets of investments?
• For most retirees, their goal is to continue to grow their portfolios in retirement and maintain a certain lifestyle without ever having to worry about running out of money.
• The inherent risk of a fund is revealed by the ‘Standard Deviation’ of the fund.
• The month-end NAV of the last 10 month until present day is available in the table below.
• Alpha is quite a significant number when evaluating mutual fund risk.

In investing, standard deviations are generally demonstrated with the use of Bollinger bands. Developed by the technical trader John Bollinger in the 1980s, Bollinger bands are a series of lines that can help identify trends in a given security. Standard deviation from the mean represents the same thing whether you are looking at gross domestic product (GDP), crop yields, or the height of various breeds of dogs. Moreover, it is always calculated in the same units as the data set.

In other words, if you want a portfolio that moves like the benchmark, go for a portfolio with high R-squared. Thus, the investor now knows that the returns of his portfolio fluctuate by approximately 10% month-over-month. The information can be used to modify the portfolio to better the investor’s attitude towards risk. A Multi-Cap portfolio of stocks that consists of tactical bets and long-term winners that generate index-beating returns.

If an asset’s value does not follow the normal distribution pattern, the calculation of standard deviation would not be accurate. A standard deviation in investing is a measure of volatility regarding investment returns. The larger the standard deviation, the wider the range of returns tends to be. In contrast, an investment with a small standard deviation tends to have more consistent returns. In simple terms, a greater standard deviation indicates higher volatility, which means the mutual fund’s performance fluctuated high above the average but also significantly below it. Therefore many investors use the terms volatility and standard deviation interchangeably.

I’ve captured this from Value research; these attributes belong to Tata Multicap fund. As you can see, the fund is benchmarked against S&P BSE 500 TRI. This is where it gets a little tricky and I have maintained all through the post that “stable” should not be construed as safe or better assets.

This is because a large cap fund also tracks closely to the movements of its benchmark i.e. Each week, Zack’s e-newsletter will address topics such as retirement, savings, loans, mortgages, tax and investment strategies, and more. ‘Ratio’ is a simple and basic mathematical tool used to understand relationship between two numbers. It is important for financial advisors to understand the way in which ratios are used to evaluate the performance of a Mutual Fund Portfolio.