Although it has limited technical utility, the standard deviation is probably the simplest measure of understanding investment risk. Therefore, it has great practical value when it comes to ‘product positioning’ as the fund industry calls it.
‘Where does a given fund fall in the risk vs reward map?’. AMC often given a product positioning risk vs reward ‘map’ in their presentations. This is for HDFC Equity Savings fund.
Source: HDFC Product presentation
They have now ‘positioned’ their equity savings funds bang in the middle. Just below balanced funds and just above debt funds.
Such illustrations give the incorrect impression that higher the risk, higher the reward. The reality is,
higher the risk, higher the potential for reward and equally higher the potential for loss.
The simplest way to represent this is the standard deviation.
The 3-year return for a few equity funds are shown above. The black dots represent the actual value of the return. The vertical line segments on each black dot represents the standard deviation. Higher the standard deviation, higher the length.
Technically, the length of the line represents the spread in monthly returns about the average monthly return. However, it is an excellent measure of what the return would be after a 3-year investment period.
Now let us represent all equity and debt funds in the same way.
Notice that the return spreads are very small to the left. These are for short-term debt mutual funds. Gradually the spread becomes bigger and bigger.
One the right extreme are equity sector mutual funds. Just below them diversified mutual funds. Right in the middle are the hybrid funds. Equity savings funds would be found somewhere close to the red arrow.
This is the reality – higher the risk taken, higher the spread in returns. I love to depict this as,
Maybe this should be freefincal’s cover picture!
Understanding risk is the key to successful mutual fund investing
A plot published earlier. The y-axis is 3-year return divided by the 3-year standard deviation.
Can you guess where equity savings funds would be positioned?
Read more:
How to select mutual fund categories suitable for your financial goals?
How to Select Debt Mutual Funds Suitable For Your Financial Goals?
Connect with us on social media
- Twitter @freefincal
- Subscribe to our Youtube Videos
- Posts feed via: Feedburner
- We are also on Google PlusandPinterest
Do check out my books
You Can Be Rich Too with Goal-Based Investing
My first book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create customg solutions for your lifestye!Get it now. It is also available in Kindle format.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
My second book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a youngearnerThe ultimate guide to travel by Pranav Surya
This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for ₹199 (instant download)Create a "from start to finish" financial plan with this free robo advisory software template
Free Apps for your Android Phone
All calculators from our book, “You can be Rich Too” are now available on Google Play!Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)
