standard deviation

Example

“Stocks have a higher standard deviation than bonds — their returns vary more widely around the historical average.”

Memory Tip

STANDARD DEVIATION = how much returns spread around the average. Higher = more volatile = more risk.

Why It Matters

Standard deviation helps you understand how risky an investment is by showing how unpredictable returns might be. A lower standard deviation means more stable, predictable returns, while a higher one indicates wild swings that could affect your financial goals and stress levels.

Common Misconception

Many people think standard deviation directly tells you how much money you will lose, but it actually only measures how spread out returns are from the average. A high standard deviation does not guarantee losses; it simply means returns vary more dramatically in both directions.

In Practice

Consider two investment funds with an average annual return of 8 percent. Fund A has a standard deviation of 5 percent, while Fund B has a standard deviation of 15 percent. In typical years, Fund A returns between 3 and 13 percent, whereas Fund B might return between negative 7 and 23 percent, showing Fund B is much more volatile despite having the same average return.

Etymology

STANDARD (established measurement) DEVIATION (departure from the average). How far returns DEVIATE from average.

Common Misspellings

Related Terms

More in investing

Other investing terms you should know

See Also