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How much risk to take? Assessing fund volatility

Thursday - 5/2/2013, 4:39pm  ET

AP Personal Finance Writer


That sounds good, right?







Few are interested in discussing statistical measures: "Unless you get a client who's an engineer, or some other analytical type, you're not going to talk about Sharpe ratios," Caplan says. "They just want to know that I'm taking measures to mitigate risk."

Yet investors can benefit if they know how to use these tools. Here's a look at 6 measures and their strengths and weaknesses:




The critical factor is whether the fund limited losses during market declines. How many investors complain about a fund that outperforms in a rally? "Investors don't care much about relative volatility," says Shannon Zimmerman, a Morningstar fund analyst. "They care whether they lost money, and how much. That's why volatility does not equal risk."


A measure of how widely a fund's returns have varied compared with the market. For example, the standard deviation of the S&P 500 over the past 3-year period has been 15.01, and 18.8 over five years, according to Morningstar. Funds with figures below those numbers have been less volatile, and those above more volatile. Standard deviation is useful to help predict the range of returns to expect based on a fund's past results. High deviation suggests it may be a relatively bumpy ride.




This less widely known refinement of the Sharpe ratio is one of Zimmerman's and Caplan's favorites because it focuses on a fund's volatility when stocks fall. As a result, it measures a fund's success in limiting losses, unlike Sharpe, which also measures volatility when stocks rise.



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