Understanding Standard Deviation in Investments
What is Standard Deviation?
Standard deviation is a statistical measure that quantifies the dispersion or variability of data from its
expected value. In investment terms, it indicates how much current returns deviate from historical normal
returns.
Why Does It Matter for Investors?
Standard deviation helps assess investment risk. When comparing similar investments, those with higher standard
deviations experience:
- Higher volatility
- Wider range of possible outcomes (both higher and lower)
- Greater potential for returns above or below the average
- Higher level of associated risk
Key Takeaway: The higher the standard deviation, the greater the range of possible outcomes,
resulting in more volatility and potential risk.
Real-World Example: Fund Comparison
Let's compare three different types of funds to see how their standard deviations reflect their risk
profiles:
| Fund |
Type |
Composition |
Standard Deviation |
Risk Level |
| Vanguard S&P 500 Index |
Index Fund |
500 largest US stocks |
Medium-High |
Medium-High |
| Wellesley Fund |
Balanced Fund |
40% stocks, 60% bonds |
Low |
Low |
| Fidelity IT Services Fund |
Concentrated Tech Fund |
Focus on payment processing companies (Visa, Mastercard, PayPal, etc.) |
High |
High |
Low Volatility
(Wellesley Fund)
Medium Volatility
(S&P 500 Index)
High Volatility
(IT Services Fund)
How to Use This Information
When evaluating investments:
- Lower standard deviation suggests more stable, predictable returns (potentially lower risk)
- Higher standard deviation indicates more unpredictable returns (potentially higher risk)
- Choose investments whose volatility matches your risk tolerance and investment goals
Finding Standard Deviation Data
While you can calculate standard deviation yourself using statistical formulas, it's easier to find this
information:
- Most financial websites provide standard deviation for mutual funds and ETFs
- Individual stock standard deviations may be harder to find but are available on premium financial platforms
- Fund prospectuses and fact sheets typically include standard deviation data