Standard Deviation in Mutual Fund

 Standard Deviation appears to be a very technical term and seems like something only a finance professional could be able to understand. Well, that’s far from the truth! In this blog, we’ll discuss standard deviation for mutual funds and standard deviation formula in mutual fund in a beginner-friendly, simple manner.

What is Standard Deviation?

Standard Deviation is a measure of how much a fund’s actual returns differs from its expected returns. It is a measure of volatility, higher the SD, higher the volatility, higher the risk.

How to interpret Standard Deviation in mutual funds?

Standard Deviation helps in measuring the risk associated with a mutual fund. It’s a value that helps women understand how much the returns of a mutual fund will vary from the average return.

• A High standard deviation means the returns from a mutual fund are volatile, i.e. they are more likely to vary from the average returns of the mutual fund.

• A Lower standard deviation means the returns from a mutual fund are more stable, i.e. they are more likely to be close to the average returns of the mutual fund.

How is Standard Deviation calculated?

Step 1: Note the yearly mutual fund returns for a specific period (ex- 3 years)

Step 2: Calculate their mean

Step 3: Subtract the yearly investment returns for every year from the mean 

Step 4: Square the resulting figures

Step 5: Add up the squares 

Step 6: Divide this number by the number of periods for which returns have been takenStep 7: Calculate the square root of this final number to arrive at SD.

Let’s understand how to compute SD through an example:

Consider that returns of a Mutual Fund XYZ for the last 5 years is as follows: (STEP 1)

Year	1	2	3	4	5
Returns	9%	11%	12%	10%	7%

Mean = 9+11+12+10+7/5 = 9.8% (STEP 2)

Year	Actual Return – Mean(STEP 3)	(Actual Return – Mean)^2(STEP 4)
1	(0.8)	0.64
2	1.2	1.44
3	2.2	4.84
4	0.2	0.04
5	(2.8)	7.84
TOTAL		14.80 (STEP 5)

(STEP 6) =  14.80/ 5 =2.96

(STEP 7) Standard Deviation = Square root to 2.96 = 1.72 

So, this means the fund’s returns may vary by 1.72% from the mean or average returns of the fund i.e. 9.8%.

What is the importance of the standard deviation formula in mutual fund?

• Risk Evaluation: Provides a measure of risk. Tells women how much actual  performance has varied from average performance over a period of time.

• Portfolio Diversification: Understanding standard deviation for mutual funds allows women to include in their portfolio funds with different Standard Deviations, and therefore, spread out their risk and reduce overall portfolio volatility.

• Performance Measurement: It assists in performance measurement of a fund. A fund with higher SD suggests more volatility while a fund with lower SD will tend to have more stable returns. 

To sum up, standard deviation for mutual funds is a risk measurement tool that can help women investors make an informed choice while selecting a mutual fund to invest in!

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