Standard deviation of a mutual fund is a mathematical measure of the variability of a mutual fund's performance over a specified period of time. A fund's returns likely fluctuate over time, and a fund's standard deviation shows fund investors how volatile the fund's returns could be from one year to the next, helping to define the riskiness of a fund. The higher the standard deviation of a mutual fund is, the riskier the mutual fund, and vice versa. In general, mutual funds with lower standard deviations present investment returns that are more stable over time.
Standard Deviation Definition
As a measure of mutual fund performance variation, a standard deviation compares potential returns from different years with the fund's mean, or average, return. In other words, a series of number of investment returns over time are quantified to see how those return numbers have varied around the mean value. The variation can be both positive or negative, that is, above the average number sometimes and below the average number other times. For individual fund investors investing in only certain periods of time, the lower the fund deviation is, the closer their expected returns to the targeted average.
Standard Deviation Possibility
Since fund returns are often expressed in a percentage, a standard deviation may also be stated as a percentage. Suppose the average return of a fund is 15 percent and its standard deviation is 2 percent, the standard deviation represents a range between 17 percent (15 percent plus 2 percent) on the high end, and 13 percent (15 percent minus 2 percent) on the low end. Fund returns for any randomly selected years will fall into that range most of the time. To further increase the possibility of future returns falling between a set of known parameters, investors could expand the scope of the deviation. If total deviation is set at two times of the standard deviation -- 2 times 2 percent equals 4 percent -- fund returns will fall between 19 percent (15 percent plus 4 percent) and 11 percent (15 percent minus 4 percent) almost every time.
Standared Deviation Comparison
Standard deviation is not an absolute number and must be used within certain context. Investors simply cannot know whether a standard deviation of 5 percent or 10 percent is low or high without making comparisons. A 5 percent deviation could be too high for a fund if other similar funds have a deviation that is relatively lower. On the contrary, a 10 percent deviation could be too low for a fund if other funds in the same group all have a much higher standard deviation.
Zero Standard Deviation
Zero standard deviation is a special case in measuring mutual fund performance variability where investment returns remain the same over time. If a mutual fund returns 1.25 percent every month over the years, there would be no change in the fund performance, resulting in a zero standard deviation. In cases where investment returns are positive, a zero standard deviation represents the least risk possible for a mutual fund. However, a zero standard deviation can also be deceptive when such constant returns are negative numbers of investment losses.