How To Assess Risk in Mutual Funds and Pick the Right One?

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In an ideal world, investments would move in a smooth path in an upward direction, perfectly in line with the market conditions. But this is not the case in reality – the fluctuations might be rather stark and erratic. Though often less volatile than stocks, mutual funds are no exception to volatile, erratic behaviour. Standard deviation is one such measure that helps trace the behaviour of an investment with fluctuations and changes in the market over time.

Volatility refers to the extent to which a fund’s net asset value fluctuates over a period of time. It is usually measured by calculating the average difference between the highest and lowest price of the asset. Upon any change, the updated Terms of Use will be updated on the Website or any other means. Your continued use of the facilities on this Website constitutes acceptance of the changes and an Agreement to be bound by Terms of Use, as amended.

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An investor who would prefer a less bumpy ride would choose Fund B. Take a square root of the obtained value to determine the standard deviation. Hence, looking at these ratios in conjunction with each other provide you with a broader picture and helps you make a more informed decision. Below are some key measures which can be helpful to assess / valuate the Mutual Funds. Trading in “Options” based on recommendations from unauthorised / unregistered investmentadvisors and influencers.

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The term Alpha is basically used to describe the excess return of the fund over and above the benchmark returns on a risk adjusted basis. So ideally alpha is the value that the portfolio manager will add or subtract from a fund portfolio’s return after adjusting what is standard deviation in mutual fund for beta of the portfolio. An alpha value of 2 means that the fund has outperformed its benchmark index by 2%. The higher the alpha value the more beneficial it is for investors. Thus, the wider the spread of the data, the higher is the standard deviation.

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what is standard deviation in mutual fund

These instruments quantify the performance, response, and interaction of a Mutual Fund in the stock market. It is simply a measure of the correlation of the portfolio’s returns to the benchmark’s returns. Next, let’s look at another important metric that gives us an idea of a mutual fund’s return performance but in relation to the risk taken by the fund manager. Assuming that the DSP Small Cap has an average return of 21.88% over the last 10 yr, about 68% of the time, the fund’s returns would fall between 3.07% (which is 21.88 – 18.81) and 40.69% (which is 21.88 + 18.81). Let’s look at the DSP Mutual Fund schemes to get an idea of how to look at standard deviation. As you may notice below, the standard deviation of the DSP Small-Cap fund is the highest (18.81%), while that of its flexi cap fund (which is essentially a proxy for large-cap) is the lowest (17.24%).

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In fancy finance jargon, this dispersion is called standard deviation. The higher the standard deviation of an asset – whether individual stocks or mutual funds – the greater the risk. ABCL and ABC Companies are engaged in a broad spectrum of activities in the financial services sectors.

what is standard deviation in mutual fund

Variance stands for the average of the squared differences in relation to the mean. The variance can be calculated by getting the difference of each point from the mean. The next step is to find the difference square and average the results. Further, the other problem with calculating risk going only by the definition of standard deviation is that while you will arrive at a figure, there is always a dilemma whether it is low or high.

This means that returns that are above average will increase the SD the same way as returns that are below the average. The standard deviation tends to be lower over a longer period of time as compared to shorter time periods. By the definition of standard deviation, it is a measure of volatility, Sharpe Ratio measures risk-adjusted performance or how well a fund performs compared to its volatility.

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When a fund has a high standard deviation, its range of performance has been very wide, indicating that there is a greater potential for volatility. The standard deviation figure provided here is an annualized statistic based on 36 monthly returns. By definition, approximately 68% of the time, the total returns of any given fund are expected to differ from its mean total return by no more than plus or minus the standard deviation figure.

Standard deviation is a statistical measure but widely applied in the finance industry and engineering field, to name a few. In financial measurements, the standard deviation’s application is found in obtaining historical volatility in prices or price movements. The results help determine the returns on investment over a period of time.

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  • A beta of 1 implies that the investment’s price will move in lock-step with the market.
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  • When seen in mutual funds, it tells you how much the return from your mutual fund portfolio is straying from the expected return, based on the fund’s historical performance.

Similarly, an asset can also be selected based on an asset manager’s alpha in Mutual Funds. It is used by investors to measure the return provided by a fund in comparison to the risk it carries. The process of calculating the Sharpe ratio includes deducting the risk-free rate from the mean figure. Simply, it helps analyse the profits earned from varying degrees of risk. In other words, it represents the risk-adjusted return of an investment. Suppose, the beta ratio of a specific Mutual Fund is 0.7 or 70%; it means the fund is 0.3 or 30% less volatile than the benchmark index.

A standard deviation is a number that can be used to show how much the returns of a mutual fund scheme are likely to deviate from its average annual returns. When applied to historical returns over a period, the standard deviation can be used as a tool to measure the volatility of a fund. However, it is essential to understand that standard deviation works based on the law of averages, and just like all other spheres of life, averages can neither be good or bad on their own.

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Standard deviation refers to a measure in statistics to find the dispersion in a dataset and its relativity to its mean. The formula to calculate standard deviation is the square root of the variance after obtaining each data point’s deviation in relation to its mean. In case the data points are farther from the mean, that means there is a higher deviation in the data set. For example, a growth-oriented fund or an emerging market fund will have greater volatility than a debt fund. But just because a fund has a higher standard deviation, it does not automatically imply that the fund is performing worse off than a fund with a lower standard deviation. The deviation tends to become a secondary consideration if the former fund performs better irrespective.

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