When investing in a mutual fund, returns are frequently used as an evaluation metric. In addition to returns, a reasonable risk assessment will assist you in making prudent decisions. Using the statistical instrument standard deviation is one method for evaluating risks and volatility. The standard deviation, a ratio commonly used by fund managers, is of significant help to investors. Let's understand standard deviation and how it can help you assess risk more accurately.
A standard deviation refers to a statistical tool for measuring the deviation of portfolio returns from their mean. The standard deviation helps to determine the investment risk. When investing in market-linked instruments, it is a crucial metric to consider. Due to the volatility of the markets, returns fluctuate daily. Both internal and external factors influence these fluctuations.
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A mutual fund's standard deviation indicates its volatility. Moreover, it indicates the deviation of a fund's returns from the projected returns based on its past performance.
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.
It is common practice to use the trailing monthly returns of 3, 5, and 10 years to determine the standard deviation. In addition, the monthly standard deviation values are converted to an annual basis and expressed as a percentage.
Here is the formula that can help you to calculate the standard deviation:
S= √( (∑ (xi- x ̅ )2 )/(n-1))
Here is a step-by-step process for calculating the standard deviation:
Standard deviation plays an essential role in mutual funds. Here is its importance:
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.