Standard Deviation

"Standard Deviation" is a commonly used measure of investment risk — measuring the historical volatility of an investment's returns. More specifically, standard deviation measures the extent to which returns, monthly or quarterly mutual fund returns for example, are spread around the average return for a period of time. Investment risk is often assessed using standard deviation over time periods of three years or longer. Standard deviations for shorter periods may be misleading, for typical investor analysis, since a single data point may significantly influence the result.

A larger standard deviation reflects larger historical volatility, while a lower standard deviation reflects lower historical volatility.

For example, the two hypothetical funds below both averaged 18% (arithmetic average) for the five periods shown; however, the Bumpy-Ride Fund's returns fluctuated more from period to period than those of the Smooth-Sailing Fund. That increased variability, or "volatility risk," is reflected in the Bumpy-Ride Fund's higher standard deviation of 14.8%, compared to Smooth-Sailing Fund's standard deviation of 2%.

The example above, featuring two hypothetical funds, is intended to illustrate the concept of standard deviation and does not imply that a 14.8% standard deviation is high or that a 2% standard deviation represents a low standard deviation target.

Standard deviation is only one of the tools used to measure investment risk. When applied, standard deviation should serve as a relative measure to compare a specific fund with its benchmark, peer group, or other funds over the same time period. As illustrated in the example above, standard deviation may be used in conjunction with the fund's performance to assess whether the level of volatility is justified by the fund's performance.

Past volatility or performance is no indicator or guarantee of future results.