Introduction to Looking at Historical Risk: Standard Deviation and Beta

Most natural risk-takers—mountain climbers, extreme athletes, motorcycle daredevils—tend to talk about the high of a job well done, an adventure completed, a successful free fall, and so on. They’re less likely to dwell on bones broken, damaged equipment, and the heavy insurance costs that surely dog them.

Investors tend to behave a little like these extreme athletes, at least when they’re starting out: They would much rather talk about the returns their funds generated than the risks they took to achieve those returns or the losses they’ve incurred. Tremendous gains are won only through tremendous risk taking, which often means many ups and downs in short-term returns. That’s called volatility.

In this lesson, we’ll tackle two common yardsticks for measuring a mutual fund’s risk: standard deviation and beta. Both of these measures appear often appear in the financial media.