What is Standard Deviation in Mutual Funds?

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Let us help you better understand the standard deviation meaning in mutual funds so that you can understand risk. While the significance of standard deviation in evaluating investment risk is well-acknowledged, relying solely on it has its downsides. For example, a fund with a low standard deviation could still incur losses due to poor asset allocation, although such scenarios are uncommon.

This multi-metric approach provides a more nuanced understanding of the inherent risks of your investment choices. You must compare a fund’s standard deviation to other schemes in the same category to determine whether it is high or low. Debt mutual funds are one example of a low-risk strategy with a low standard deviation.

• Hence, it may underestimate extreme event risks and does not differentiate upside from downside volatility.
• Conversely, a low standard deviation results in much steadier returns, making the fund safer.
• The comparison allows investors to make more informed decisions about where to allocate their money based on their financial goals and risk appetite.
• Understanding standard deviation allows you to gauge a fund’s volatility.
• In contrast, large-cap funds, which invest in well-established companies, generally experience smaller price swings.

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This can be mapped to your own risk appetite in order to decide if a fund works for you or not. The importance of standard deviation as an accepted risk assessment parameter has now been established. It is vital to bear in mind that despite all the advantages of standard deviation using it alone as a risk assessment tool can have its limitations. There may be a fund with a low standard deviation that may lose money due to poor portfolio composition although such cases are rare. As explained above a greater standard deviation in a fund indicates greater volatility.

We then subtract the mean what is standard deviation in mutual fund from each return to get the deviation from the mean. We square each deviation, add them up, and divide by the number of observations minus one. Finally, we take the square root of the result to get the standard deviation. If you are really serious about fund analysis, you need to understand this is all about judging returns and risk. Stripped of a lot of complexity, this task involves determining a fund’s average performance over a period of time. So, this means the fund’s returns may vary by 1.72% from the mean or average returns of the fund i.e. 9.8%.

If the first fund is a much higher performer than the second one, the deviation will not matter much. To understand how standard deviation works, let’s take an illustration. Standard deviation is a statistical measure illustrating the amount of variability or dispersion around an average. Mentions of stocks or investment products are solely for informational purposes and do not constitute recommendations. Investors should conduct their own research before making any decisions. In banking, the standard deviation is used in the credit scoring process, which predicts the probability of a borrower defaulting on a loan.

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The standard deviation of return will be higher in equity funds due to the stock market volatility. Debt funds usually have lower standard deviations; they depict a relatively stable return and reduce risk. This also makes it easier for investors to select an investment strategy that comes well with their risk capacity and market conditions. Determining a mutual fund’s standard deviation involves several steps to quantify return variability. By systematically analyzing past performance, investors can gauge how consistently a fund has performed relative to its average return.

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For instance, a mutual fund with a standard deviation of 3 isn’t automatically better or worse than another fund with a standard deviation of 4 or 2. When picking a fund, you can utilize standard deviation to evaluate the level of risk that aligns with your own risk tolerance and investment horizon. Say, for example, fund A is riskier than fund B; you’d select the one that best aligns with your comfort level for taking on risk. When investing in mutual funds, we frequently use returns as a criterion for evaluation. A reasonable estimate of risk and returns can aid you in making a wise decision. The standard deviation statistical tool can be used to evaluate risks and volatility.

In other words, returns of funds with a high standard deviation may fluctuate either on the higher or lower side of the average and may be said to lack consistency. Next, each deviation is squared, and the squared values are averaged to determine variance. Squaring removes negative values, ensuring fluctuations above and below the mean contribute equally.

The meaning of standard deviation helps you measure the volatility factor of a fund. Thus, if a fund has a standard deviation of 7% and an average return of 15%, it will be expected to give average returns in the range of 8-22%, deviating by 7%. As you can see the 1st mutual fund is more in line with the category and index performance while the second has a higher standard deviation implying higher volatility. Again this is not to say that Nippon India Large Cap’s standard deviation is not favorable. As an investor, you can take a call depending on your return expectations and risk appetite. Investors should note that the fund has a 5-year beta of 0.99, which means it is hypothetically as volatile as the market at large.

What Does Standard Deviation Measure?

• If data points are widely spread out from the mean, the standard deviation is large.
• On the other hand, a low standard deviation indicates the fund’s returns are more consistent and closer to the average returns.
• Though such instances are uncommon, it is possible for a fund with a low standard deviation to have financial losses because of subpar portfolio composition.
• It also does not differentiate between positive and negative deviations from the mean.
• If you’re interested in shorter time frames, do not dismiss looking at the fund’s 3 -year annualized total return of 7.8%, which places it in the top third during this time-frame.

If you have a lower risk tolerance or are nearing retirement, low standard deviation funds may offer the stability you need. The amount by which the returns of a mutual fund scheme are likely to depart from their average yearly returns can be stated as a figure (expressed as a percentage) known as the standard deviation. The standard deviation can be used to assess a fund’s volatility when applied to historical returns over time. It is crucial to realise that standard deviation is founded on the law of averages and that averages cannot be good or bad on their own, just like in all other areas of life.

This deviation is a crucial ratio typically utilised by fund managers that benefit investors. To better assist you in evaluating risk, let’s explore the standard deviation. Standard deviation represents one of the most important statistical tools for mutual funds. By analyzing each scheme’s projected range of volatility, it enables you to choose funds that best meet your risk tolerance. Despite the usefulness of standard deviation, investors should never choose mutual funds entirely on the basis of statistical tools. Other data elements, like Alpha and Beta, require equal consideration.

Comparing standard deviation

Metrics such as the Sharpe ratio, which adjusts returns for risk, help assess whether a fund’s volatility has historically been rewarded with higher performance. A low Sharpe ratio suggests that the fund’s fluctuations have not translated into meaningful excess returns, potentially making it less attractive for risk-averse investors. Because market conditions change, knowing how much a fund’s returns deviate from the average provides insight into potential risks.

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. Comparing return fluctuations against relevant benchmarks provides further insight into a fund’s behavior. If a mutual fund exhibits significantly higher volatility than its benchmark index but fails to generate proportionally greater returns, investors may question whether the added risk is justified.

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Moreover, you cannot determine whether a fund’s standard deviation is high or low without comparing it to other investments in the same category. Low-risk investments, like debt mutual funds, have a standard deviation that is typically low. In contrast, equity-based funds will have a greater standard deviation than debt-based funds. The risk levels of varied funds can be easily compared with this metric, which helps the investor make a more informed investment decision. For instance, more risk-averse investors may like a portfolio with a more minor standard deviation for stability.

A higher standard deviation indicates that the returns could differ substantially from the average value, making it an even higher risk. Conversely, a low standard deviation results in much steadier returns, making the fund safer. In contrast, large-cap funds, which invest in well-established companies, generally experience smaller price swings. We classify FIVFX in the Non US – Equity category, which is an area rife with potential choices. Investing in companies outside the United States is how Non US – Equity funds set themselves apart, since global funds tend to keep a good portion of their portfolio stateside. Many of these funds like to allocate across emerging and developed markets, and will often focus on all cap levels.