Complete Guide To Investment Companies, Funds And REITs


Introduction - Standard Deviation

Standard deviation is a statistical measurement that sheds light on historical volatility. For example, a volatile stock will have a high standard deviation, while the deviation of a stable blue chip stock will be lower. A large dispersion tells us how much the return on the fund is deviating from the expected normal returns.

Standard deviation is so widely used because it is expressed in the same units as the original data, so it is easy to interpret and can be used on distribution graphs (e.g., the normal distribution).

As it relates to investing, an index fund can be expected to have a low standard deviation versus its benchmark index, as the fund's goal is to replicate the index. Aggressive growth funds, on the other hand, can be expected to have standard deviation as the portfolio manager makes aggressive bets in an effort to generate higher-than-average returns.

While, intuitively, a lower standard deviation may seem preferable, that is not necessarily the case. When considering the amount of deviation in a portfolio, investors should consider both their personal tolerance for portfolio volatility and the investment objective of the strategy under consideration. More aggressive investors may be comfortable with an investment strategy that offers higher-than-average volatility, while more conservative investors may not.

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