Is variance good or bad for stock investors?

Variance is neither good nor bad for investors in and of itself. However, high variance in a stock is associated with higher risk, along with a higher return. Low variance is associated with lower risk and a lower return. High-variance stocks tend to be good for aggressive investors who are less risk-averse, while low-variance stocks tend to be good for conservative investors who have less risk tolerance.

Variance is a measurement of the degree of risk in an investment. Risk reflects the chance that an investment's actual return, or its gain or loss over a specific period, is higher or lower than expected. There is a possibility some, or all, of the investment will be lost.

A 30-year-old executive, stepping upward through the corporate ranks with a rising income, can typically afford to be more aggressive, and less risk-averse, in selecting stocks. Investors of this kind usually want to have some high-variance stocks in their portfolios. In contrast, a 68-year-old on a fixed income is likely to make a different type of risk/return tradeoff, concentrating instead on low-variance stocks.

However, according to modern portfolio theory (MPT), it is possible to reduce variance without compromising expected return by combining multiple asset types through asset allocation. Under this approach, an investor builds a diversified portfolio that includes not just stocks but asset types such as bonds, commodities, real estate investment trusts, or REITs, insurance products and derivatives. A diversified portfolio might also include cash or cash equivalents, foreign currency and venture capital, for example.

Financial professionals determine variance by calculating the average of the squared deviations from the mean rate of return. Standard deviation can then be found by calculating the square root of the variance. In a particular year, an investor can expect the return on a stock to be one standard deviation below or above the standard rate of return.

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