The standard deviation of a mutual fund is a number that indicates the volatility of the fund. It is determined by looking at the average performance of the fund over a period of time. A very high standard deviation number indicates that the fund is volatile and subject to frequent changes, possibly indicating a risky investment. Before reaching a final decision, investors should consider other factors in addition to a fund’s standard deviation.
“Standard deviation” is defined as the amount that a set of data varies from the mean. The further that the data is spread out, the higher the amount of deviation. When applied to a mutual fund, the standard deviation provides insight into the volatility of the fund, as viewed over a period of time. Many investors use this number as a gauge for determining how safe or risky a particular mutual fund is likely to be in the future.
To determine the standard deviation of a mutual fund, it is first necessary to determine the mean for the fund over a fixed period of time. To determine the mean of a fund for the past three years, for example, the annual returns for each year are noted and added together, then divided by the number of years. If the fund returned 20% the first year, 15% the second year and 10% the third year, the mean return would be 15%. This means that the standard deviation for years one and three is 5%, and for year two it would be zero.
One problem with trying to make an investment determination based strictly on the standard deviation is that this number alone does not indicate profit or loss, only change. A fund that increases by five points every month and a fund that decreases by five points every month will both show the same standard deviation. Investors should be careful to use this figure as a guideline but not as the only measure of a fund’s risk.
The standard deviation for a fund should always be considered in relation to other funds. Investors should compare it to other, similar types of funds to see if the deviation is particularly high or low for the fund’s type. Because it is impossible to tell if a standard deviation value represents a gain or a loss, other factors must be considered when choosing mutual fund investments. Indicators such as the dividend yield and the total return, which show how a fund has performed in the past, are very useful when assessing a fund.
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