Standard Deviation
A measure of volatility, or risk, inherent in a security or portfolio. Standard deviation quantifies the extent to which observed returns differ from the average return over a period.
A higher standard deviation means more variable returns — greater uncertainty about what the investor will actually receive in any given period. Standard deviation treats upside and downside deviations equally, which is why the Sortino Ratio (downside deviation only) is sometimes preferred.
Example: 10% avg return, 5% std dev ⇒ ~68% of years, return falls between 5% and 15%
Standard deviation is the foundation of modern portfolio theory and remains the most common measure of investment risk. It is used to calculate the Sharpe ratio, construct efficient frontiers, and determine portfolio risk budgets.
Frequently Asked Questions
What is standard deviation in investing?
Standard deviation measures the volatility of investment returns — how much returns vary from the average over time. Higher standard deviation means more uncertainty about future returns.
How is standard deviation used in portfolio management?
Standard deviation is used to calculate risk-adjusted performance (Sharpe ratio), construct efficient frontiers, determine risk budgets, and compare the volatility of different investment strategies.
What is a good standard deviation for a portfolio?
There's no universal 'good' standard deviation — it depends on the strategy. Equity portfolios typically show 15-20% annualized standard deviation, while fixed income is usually 3-6%. The key is whether the return justifies the risk.
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