Investing in financial markets are subject to market risks, and past performance does not guarantee future results. It is advisable to consult a qualified financial professional, review official documents, and verify information independently before making investment decisions. No, standard deviation should be used along with other measures like beta, alpha, and Sharpe ratio to get a comprehensive view of a mutual fund’s risk and performance. 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). 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.
Importance of Standard Deviation in Risk Assessment
- Again this is not to say that Nippon India Large Cap’s standard deviation is not favorable.
- This metric is widely used in fund comparisons and investment decisions, making it essential for both new and experienced investors.
- Standard deviation, typically presented as a percentage, indicates the extent to which the returns of a mutual fund scheme may differ from its average annual returns.
Standard deviation can be defined as a statistical measure expressed as a percentage that indicates the level to which returns of a mutual fund can deviate from its mean annual returns. It is an effective way of measuring the degree of risk and volatility of a mutual fund scheme. Suppose the standard deviation of a mutual fund comes out to 3%, and the average annual return of the same is 15%. Now that we have understood the definition of standard deviation with respect to mutual funds, let’s take a close look at the standard deviation calculation formula. In the context of mutual funds, standard deviation measures the fund’s volatility, or how widely its returns can vary from the average return over a specific period. Essentially, it quantifies the degree of unpredictability you can expect from the fund.
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It helps you choose a fund whose risk levels you are comfortable with, contributing to better investment decisions. However, you must consider the fact that standard deviation also has some limitations as well. In statistics, the standard deviation measures the amount of variation for a set of data. For mutual funds, the standard deviation measures the variation of returns against a market index or another fund. When investing in a mutual fund, returns are frequently used as an evaluation metric.
Which type of mutual funds tend to have lower standard deviation – equity funds or debt funds?
For aggressive investors willing to take on more risk, high standard deviation funds can offer the potential for higher returns. A mutual fund standard deviation is a percentage that shows how much a fund’s returns might vary from its average annual return. Analyzing the benchmark returns will measure the fund’s variability when calculating the standard deviation of mutual fund returns over periods.
Hybrid funds
Hence, it may underestimate extreme event risks and does not differentiate upside from downside volatility. Reliance on standard deviation alone as a measure of risk is not advisable. Therefore, using this metric with other risk measures is essential for a more comprehensive analysis of mutual funds. Critics of the fund industry argue that the expenses for many mutual funds are too high. They believe that the market for mutual funds is not as competitive as it should be and that there are often many hidden fees so that it can be difficult for investors to understand and minimize the fees that they pay.
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By measuring how much a fund’s returns deviate from its average, standard deviation helps investors gauge the consistency and reliability of a fund’s performance. A lower standard deviation in mutual funds indicates more stable returns, while a higher standard deviation points to greater variability and potential risk. Mutual Funds are subject to market risks, including loss of principal amount and Investor should read all Scheme/Offer related documents carefully.
The benefits discussed in the above points provide an answer to the most pressing question of how SD can help in selecting the mutual funds to invest in . We can see that the Sharpe ratio of the HDFC top 100 plan is higher and the fund provides lesser returns per unit of this volatility at 0.32. Whereas Kotak Bluechip is not only less volatile but also generates more returns per unit of volatility at 0.47. Similarly, HDFC Top 100 is more sensitive to market movements with a higher beta and a negative alpha implies that the fund may not have been able to keep up with the category returns. While choosing a fund going by the standard deviation definition you may use standard deviation as a measure of risk assessment in alignment with your own risk appetite and investment time frame.
- Sector-specific funds, such as technology or healthcare funds, can experience pronounced volatility due to industry trends, regulatory changes, or innovation cycles.
- Mean deviation tells us how far, on average, all values are from the middle.
- Regularly monitoring the Standard Deviation of your SIP investments allows you to make informed adjustments.
- For example, a portfolio heavily weighted in high-standard deviation assets may offer higher returns but also exposes investors to significant volatility.
- Aditya Birla Capital Limited is the holding company of all financial services businesses.
Common questions about mutual funds
By understanding standard deviation, you can make more informed investment decisions based on your risk tolerance and financial goals. A lower standard deviation generally indicates a less volatile fund with returns that stay closer to its average. Conversely, a higher standard deviation suggests a more volatile fund with returns that can fluctuate significantly.
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. The minimum to invest in mutual funds can range depending on the mutual fund and whether your brokerage account provides fractional investment in mutual funds.
When applied to historical returns over a period the standard deviation can be used as a tool to measure the volatility of a fund. However it is essential to understand that standard deviation works based on the law of averages and just like all other spheres of life averages can neither be good nor bad on their own. For example a mutual fund scheme with a standard deviation of 3 can only be considered better or worse than another with a standard deviation of 4 or 2. You must be wondering what standard deviation is in the realm of mutual funds. It is a numerical figure, usually presented as a percentage, which helps indicate how far a mutual fund’s returns could vary from its average yearly earnings.
Index funds generally charge a lower management fee than actively-managed funds. And affiliated banks, Members FDIC and wholly owned subsidiaries of Bank of America Corporation (“BofA Corp.”). The performance data contained herein represents past performance which does not guarantee future results. Investment return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than their original cost.