Standard Deviation and Beta: Understanding Risk Measures

For you to be well-familiarized with the risks attached to your investments, it’s imperative that you understand different risk measures. And we will first focus on Standard Deviation and Beta.

This is also important in helping you decide Investing Tips which investment provides the best and most Global Trading Platform ideal risk-reward combination. You have to understand how figures should be analyzed. This is because there are many instances where the relationship between figures from the benchmark and figures for the fund is not always discernible.

Portfolio Theory

If you have been trying to understand the relationship between portfolio returns and risk is the efficient frontier, which is an important part of the modern portfolio theory.

You can make this form on graph where you plot the return and risk indicated with volatility, which is represented by standard deviation.

As the standard deviation increases, the return also increases. If the investor needs to shoulder high levels of risk in exchange for a small return, then the portfolio is not an optimal one. You must do an in-depth analysis of the fund’s standard deviation if you want to know if the fund is an optimal one.

Standard deviation

The calculation for the standard deviation can be very confusing, but because the figure for standard deviation is very useful, a lot of mutual funds offer services that provide the standard deviation of funds.

The standard deviation basically tells you the volatility of a fund. If the security is volatile, it’s also considered to be risky. That is because its performance can change very quickly in either direction at any moment. The standard deviation of a fund tells you the risk by gauging the degree to which the fund fluctuates with regards to its mean return.

You must, however, keep in mind that volatility is just one of the indicators of risks of a security. Therefore, excellent past performance does not guarantee future stability. Unpredictable market factors can have a hit on volatility, so a fund with a good standard deviation figure this year may not have the same figure next year.

Beta

Beta is another useful risk measure. This compares the volatility or risk of a fund to an index or benchmark. A fund with a beta that is nearly 1 means that that fund’s performance closely resembles the performance of the index or benchmark. If the beta is greater than 1, the fund has greater volatility than the overall market. If the beta is less than 1, the fund may be less volatile than the benchmark.

If you are expecting the market to be bullish, you would want a fund that exhibits high beta. Such funds increase your chances of beating the market to the ground. If you think that the market will be bearish in the near future, you would prefer funds with lower betas. That’s because such funds will decline less than the index.

Being serious with your investments entails commitment to learning all the risk measures you can get your hands on. That’s because understanding risks and funds is a crucial part of an effective risk management strategy.