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Before making any investment, we should always consider the risks associated with the investment. If the risks are higher than our comfort level, then avoiding those investment options will be a better choice. In mutual funds, the standard deviation is a statistical measure that helps investors determine a scheme's volatility and risks.
Let’s understand this using an example. In the table below we have taken the yearly return data of 2 imaginary funds.
Calculation of the standard deviation involves a few steps, but we are not focusing on that aspect as this article is focused on its practical usability.
Both the funds have the same CAGR of 8% over the 5 years. But, we can see that Fund B has a higher standard deviation compared to Fund A. And we can also see that Fund A has more stable returns compared to Fund B.
So Funds with lower standard deviation will give more stable returns than their counterparts with higher standard deviation. It is essential to look at this metric because for risk-averse investors, high volatility can create panic and they may end up selling their investments at a loss.
You can find the standard deviation of any mutual fund in the performance section of the fund in Sharpely. It is defined as annualized volatility.
Different categories of mutual funds will have different values of standard deviation. For example, small-cap funds generally have a higher standard deviation compared to large-cap funds due to inherent higher volatility in small-cap stocks.
Investors can use standard deviation to determine whether a particular scheme is suitable for their risk profile. Using this mutual fund statistic, investors can analyze whether the risks associated with a fund are aligned with their own risk tolerance.
Standard deviation can be also used in a relative analysis of a mutual fund. You can compare the standard deviation of the fund with the category average. If there is a significant difference in the values then you should look for the reasons for the same.
Both standard deviation and Beta are used to analyze volatility. Both factors have their own use. If you want to analyze volatility with respect to the market then beta will be useful. But if you want to perform a standalone analysis of any mutual fund then standard deviation can be used.
Yes, a low standard deviation shows the consistency of the fund's performance. But at the same time based on this parameter alone, you should not make any investment decisions. This parameter can be used to select a fund from the shortlisted funds. For example, between two similar funds that have similar risk-return profiles, you can choose the fund with a low standard deviation.
Yes, standard deviation only measures the volatility of returns and does not take into account other factors such as the fund's performance relative to its benchmark, the quality of the fund manager, or the fees associated with the fund. When evaluating mutual funds, investors should use standard deviation along with other metrics.
