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The Risk Page | |
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What is the "Risk" figure that is usually quoted along with mutual fund performance? It is the standard deviation of the fund's returns each month over a period of time, usually 36 months. More specifically, standard deviation measures the volatility of a fund's actual monthly returns relative to the average or mean monthly return for the fund over the period. The standard deviation number used by Bellcharts/Morningstar is one standard deviation. Statistically, between the mean and one standard deviation, approximately 34 percent of all the measurements that make up the distribution will occur above the mean and 34 percent will occur below the mean. Because of the properties of normal distribution, 95 percent of the monthly measurements will occur between plus and minus two standard deviations from the mean. It is a widely accepted measurement of risk and is useful in explaining the potential short-term performance of a fund. By way of example, assume a fund has a 1 percent average monthly rate of return over a three-year period and a standard deviation of 3.0. This would indicate that the monthly returns of the fund ranged between -2 percent (mean minus 1 standard deviation) and +4 percent (mean plus 1 standard deviation) approximately 68 percent of the time. In addition, 95 percent of the time the monthly return would have fallen between -5 percent (mean minus two standard deviations) and +7 percent (mean plus two standard deviations). Basically a higher risk number means more less stable returns. But a fund that lost exactly 1% each month for 36 months would show risk number equal to 0, whereas a fund that alternated between 1% and 3% gains each month would have a risk of 1. Clearly the rising fund would be better, and as such risk is just one measure to use when evaluating funds. For more on the other factors we consider when recommending funds, see How We Analyze Funds. Knowing the potential upside and downside for any given month based on historical information adds an additional dimension to the understanding of a fund's characteristics. Similar to all historical measurement, it may be an indication of what might happen in the future but certainly does not guarantee it. | ||
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