Why Standard Deviation Matters When Choosing Investments

By Michael Helveston,
Contributor for Forbes


 

Standard deviation is a common statistical measurement and is defined by Oxford Dictionaries as: ‘A quantity expressing by how much the members of a group differ from the mean value for the group.’ In other words, it is a measure of volatility that tells you how far apart all of the values are from the average (or mean) value.

For example, if Mutual Fund A has an average annual return of 10% and a standard deviation of 4%, you would expect about 68% of the time for the return to be between 6% and 14% (1 standard deviation on either side of 10%). About 95% of the time you would expect the return to be between 2% and 18% (or 2 standard deviations on either side of 10%). This assumes the fund’s returns follow a normal distribution or what is commonly called a ‘bell curve.’ In a normal distribution, 68% of values are within 1 standard deviation of the mean, 95% of values are within 2 standard deviations of the mean and 99.7% of values are within 3 standard deviations of the mean.

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%. About 95% of the time you would expect the return to be between -20% and 40%.

As you can see, not all returns are created equal and the volatility would be much greater with mutual fund B, even though they have the same average return. In my opinion, dealing with volatility often causes people to make decisions that may not be in their best interest. If you don’t think you would react well with a fund that has wild swings, perhaps you should consider one with a lower standard deviation.

 

 


This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of the author and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected. Raymond James is not affiliated with and does not endorse the opinions or services of Michael Helveston or Forbes. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.


Warning: count(): Parameter must be an array or an object that implements Countable in /nfs/c04/h04/mnt/180996/domains/brockkidd.com/html/wp/wp-includes/class-wp-comment-query.php on line 399