Standard Deviation Definition Mutual Funds

The term may sound complex and perhaps beyond the comprehension of anyone other than a math or finance major, but using standard deviation with mutual funds can be simple and useful. If you’re wondering how to calculate the standard deviation of mutual funds in Excel? Modern portfolio theory and volatility are not the only means investors use to analyze the risk caused by many different factors in the market. And things like risk tolerance and investment strategy affect how an investor views his or her exposure to risk.

Covariance is used to measure the correlation in price moves of two different stocks. Therefore, beta is often used as a risk-reward measure which helps investors what is standard deviation in mutual fund determine how much risk they are willing to take for the desired return. Beta is a metric used in fundamental analysis to determine the sensitivity of an asset or portfolio/fund with respect to the overall market.

Why Standard Deviation Matters When Choosing Investments

1. Obviously, portfolios with a risk/return relationship plotted far below the curve are not optimal since the investor is taking on a large amount of instability for a small return.
2. Conversely, a higher standard deviation suggests a more volatile fund with returns that can fluctuate significantly.
3. The 10-year performance period is intended to strike a reasonable balance between indicator stability and the availability of data.
4. The most frequently used measurement of investment risk is standard deviation.
5. For example, calculating mean deviation is more effective when there is a high dispersion level.

Traders and analysts use a number of metrics to assess the volatility and relative risk of potential investments, but one of the most common is standard deviation. Investors often compare the standard deviation of different investments to understand their risk profiles better. A mutual fund with a lower standard deviation is considered less risky than one with a higher standard deviation, assuming the average returns are similar. This comparison helps in constructing a diversified investment portfolio that aligns with an investor’s.

Normal Distribution of Returns

The 2015 Proposal has removed the requirement to maintain records for a 10-year period when using the Proposed Methodology to determine the risk level of a fund. Instead, consistent with the existing requirement in securities legislation to maintain records for a period of seven years from the date that the record was created, managers will be required to maintain records for a seven-year period. 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. If you’ve done extensive research when analyzing mutual funds, you may have run across a statistical analysis term called standard deviation (not to be confused with downside deviation).

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. By measuring the standard deviation of a portfolio’s annual rate of return, analysts can see how consistent the returns are over time. Extreme values can disproportionately influence the measure, leading to potential misinterpretations of risk. Therefore, it’s important to consider the overall distribution of data when evaluating standard deviation. The mean (average) annual return of the mutual fund over the 5 years is 10.4.

StockEdge

In order to find the standard deviation of a multiple-asset portfolio, an investor would need to account for each fund’s correlation, as well as the standard deviation. In other words, volatility (standard deviation) of a portfolio is a function of how each fund in the portfolio moves in relation to each other fund in the portfolio. If you are deciding on buying mutual funds, it is important to be aware of factors other than volatility that affect and indicate the risk posed by mutual funds. One examination of the relationship between portfolio returns and risk is the efficient frontier, a curve that is a part of modern portfolio theory. The curve forms from a graph plotting return and risk indicated by volatility, which is represented by the standard deviation.

What is the standard deviation in mutual funds?

The standard deviation essentially reports a fund’s volatility, which indicates the tendency of the returns to rise or fall drastically in a short period of time. A volatile security is also considered a higher risk because its performance may change quickly in either direction at any moment. The standard deviation of a fund measures this risk by measuring the degree to which the fund fluctuates in relation to its mean return. It is important to note that standard deviation can only show the dispersion of annual returns for a mutual fund, which does not necessarily imply future consistency with this measurement.

Finance for Professionals

1. A growth-oriented or emerging market fund is likely to have greater volatility and will have a higher standard deviation.
2. A perfect negative correlation means that two assets move in opposite directions when the correlation coefficient is -1, while a 0 correlation implies that there is no linear relationship between the assets.
3. Naturally, by this measure, the higher the Sharpe ratio, the better it is as we all want higher returns for every unit of risk undertaken.
4. When a fund has a high standard deviation, its range of performance has been very wide, indicating that there is a greater potential for volatility.

Because if S&P Sensex 500 falls by  1%, then Tata Multicap fund is expected to fall by only 0.65% and not 0.95%. Calculating standard deviation involves complex statistical formulas. Most financial websites and mutual fund platforms display the standard deviation of a fund over various periods (e.g., 1 year, 5 years).

By applying the standard deviation formula, we find that the standard deviation of the fund’s annual returns is approximately 2.87%. Furthermore, a mutual fund exhibiting a low standard deviation over a period of 3 to 5 years suggests that the fund has maintained consistent returns over the long term. Standard deviation, often abbreviated as “std,” is a key statistical measure that assesses the dispersion or variability of a set of data points. In simpler terms, it indicates how much individual data points differ from the mean (average) value. A low standard deviation signifies that the data points tend to be close to the mean, suggesting stability, while a high standard deviation indicates greater variability and potential volatility. An investor, Rakesh, wants to calculate the beta of Stock A as compared to the Index ABC.

In these instances, the Proposed Methodology requires standard deviation to be calculated using the monthly “return on investment” of the continuing fund, or commencing from the date of the change in investment objectives, as applicable. Currently, the Fund Facts require a mutual fund to provide its risk level on a five-category scale (ranging from low to high) using a risk classification methodology selected at the manager’s discretion. No risk level or ratings are currently required by an ETF in the equivalent ETF summary disclosure documents (to be replaced by ETF Facts upon the coming into force of amendments to implement Form F4). If a folio’s returns follow a normal distribution, most of the profits will be close to the average return.

A higher standard deviation indicates greater volatility, meaning the investment’s returns can vary widely from the average return. Conversely, a lower standard deviation signifies less volatility, suggesting the returns are more likely to be close to the average. Adding established mutual funds to your portfolio, whether through a single lump sum investment or a SIP investment, can play a crucial role in helping you meet your overall financial goals in several different ways. Standard deviation is a statistical measure of the range of a fund’s performance.

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. By using the formula above, we are also calculating Variance, which is the square of the standard deviation. The equation for calculating variance is the same as the one provided above, except that we don’t take the square root. Beta by itself is limited and can be skewed due to factors other than the market risk affecting the fund’s volatility. Kindly, read the Advisory Guidelines for investors as prescribed by the exchange with reference to their circular dated 27th August, 2021 regarding investor awareness and safeguarding client’s assets.

The standard deviation for this fund would then be zero because the fund’s return in any given year does not differ from its four-year mean of 3%. On the other hand, a fund that in each of the last four years returned -5%, 17%, 2%, and 30% would have a mean return of 11%. This fund would also exhibit a high standard deviation because each year, the return of the fund differs from the mean return. This fund is, therefore, riskier because it fluctuates widely between negative and positive returns within a short period. Lastly, if the beta of the fund is higher than 1, it implies that the fund is risker compared to its benchmark. For instance, a beta of 1.2 suggests that the fund is 20% riskier compared to its benchmark.