What is standard deviation?
Standard deviation, also commonly referred to as standard deviation (or standard error), is a concept in statistics that tells you how far the numbers in a group lie from the average (spread). It’s a way to see how dispersed the numbers are. Standard deviation is often denoted by the Greek letter sigma (σ) for a population or ‘s’ for a sample.
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What is standard deviation in investing?
When we talk about standard deviation in investing, it refers to how much an investment’s returns deviate from the average over time. Standard deviation is used as a measure of volatility – how much the price fluctuates. It’s a smart way to measure the risk of an investment.
Interpretation of standard deviation: an example
To better explain the concept of standard deviation in investing, here is an example. Imagine two funds in your portfolio:
- Fund A has a low standard deviation of 5%, with returns close to the average—stable and reliable.
- Fund B, with a standard deviation of 20%, fluctuates wildly, with large gains or losses.
If you are building wealth for the long term, Fund A might suit a calm strategy, while Fund B can make things more exciting for higher risk-takers. By comparing their standard deviations, you can balance your portfolio to match your comfort level.
Why is standard deviation important in investing?
Standard deviation is important because it helps you understand how much risk you are taking with an investment. The higher the standard deviation, the greater the movements in value—and thus the greater the chance of high profits and substantial losses. A low standard deviation means more stability. With this insight, you can do the following:
- Diversify smarter: You spread your investments more effectively, which helps manage the overall risk of your portfolio.
- Align risk tolerance: You choose investments that fit the amount of risk you are willing to take.
- Invest more strategically: You can avoid surprises and focus more on your long-term goals.
Is a high standard deviation bad?
A high standard deviation is not necessarily bad. It simply means that the price of your investment moves up and down more than average. If you are mainly looking for peace of mind and steady growth, such a fluctuating investment might feel uncomfortable. However, if you want to pursue larger profits and can handle significant fluctuations, it might actually be interesting.
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Investing involves risks. You can lose your investment.
All views, opinions, and analyses in this article should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.
