What is Standard Deviation?
Standard deviation measures how spread out investment returns are from their average. If a fund has an average annual return of 10% with a standard deviation of 15%, roughly 68% of the time returns will fall between -5% and +25%. A higher standard deviation means more unpredictable returns and greater risk.
Comparing Investments
US large-cap stocks have a historical standard deviation of about 15-16%. US bonds are around 5-6%. Emerging market stocks can exceed 25%. When comparing two investments with similar returns, the one with lower standard deviation is generally preferable because it delivers the same return with less uncertainty.
Key Considerations
Standard deviation assumes returns follow a normal distribution, but real markets have fat tails - extreme events occur more often than the bell curve predicts. The 2008 financial crisis was a 4+ standard deviation event that should theoretically occur once in 31,000 years. Use standard deviation as one risk measure among several, not the sole indicator.