In my previous post we discussed “What is Risk.” As a follow-up, we will begin to explore how to measure risk. When considering investment options, analyzing performance statistics without consideration of risk does not provide a view of the complete picture.
One of the most common measurements of risk is standard deviation, which statistically measures how observations are dispersed around a central tendency. From an investment perspective, standard deviation measures how performance may be dispersed about an expected return.
For example, from January 1, 2007 through December 31, 2013, the annualized return of the S&P 500 TR Index was +6.13%. As a comparison, the return of the Barclays Aggregate Bond TR Index (Agg Bond) was +4.91%. However, the standard deviation of the S&P 500 Index was 16.91% compared to 3.44% for the Agg Bond. From an average return perspective, not much difference, however the potential dispersion is significant.