Variance is a measure of how far away a set of numbers is from the mean value. In other words, variance represents how different a group of numbers are from one another. In finance, variance is useful for measuring volatility and assessing the riskiness of a particular investment. Variance is calculated as the average of the squared differences from the mean. To calculate the variance between two numbers, you must calculate the mean of those numbers.
Calculating the Mean
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To find the mean, also called the average, of two numbers, you simply add the two numbers together and divide that answer by two. For example, to calculate the mean of 21 and 55, add them together and then divide by two.
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Mean = (21+55) / 2
Mean = 38
Calculating the Variance
Now that you have the mean of your two numbers, you are ready to calculate the variance.
Step 1
Find the difference each number is away from the mean, and then square that difference. For example, subtract 38 from 21 and then square the result. Subtract 38 from 55 and then square the result. It does not matter if you get a negative number when you subtract the mean because you will have a positive number after squaring the difference.
(21-38)2 = 289
(55-38)2 = 289
Step 2
Add together the two values you calculated in the previous step. For the example, add 289 and 289 to get a result of 578.
Step 3
Divide your solution from the previous step by two since you have two observations. Dividing 578 by 2 yields a result of 289. This is the variance between the two numbers.
Tip
When you only have two numbers, there is a shortcut for calculating the variance. You can actually stop at step 1 in the variance calculation. Taking the squared difference between each value and the mean also calculates the variance. This only works when you are calculating the variance between two numbers.