Measuring volatility in investment assets is an important process before you plan to invest.

In addition, especially while considering equity or equity mutual funds, you have to be cautious about the risks.

Moreover, one such risk I am talking about in this article is volatility.

What is volatility risk?…

Everyone wants to ride their vehicle on a highway, right? in order to reach your destination.

But the fact is, all the roads that come in your way before reaching your destination will not be smoother like High Way.

And while driving your vehicle on these dirt roads, you must be very careful.

You do not know what will happen to you once the vehicle enters any of the holes reflecting in the above image.

So, its advisable to stop for a while and access the situation and analyse it, then proceed for the ride on these dirt roads.

Similarly, everyone wants to stay invested in an uptrend market only.

But the fact is, there are phases when volatility risk will be high, and you will lose your patience and withdraw your money from the market and will never come back.

Moreover, there will be down side volatility as well, apart from up side volatility.

Measuring Volatility in Investment with Standard Deviation…

To measure volatility risk in investments, SD is the widely used statistic among many investors.

Let’s understand volatility with an example case study…

Let’s calculate the standard deviation for Hdfc small-cap fund and analyse the volatility.

I have taken yearly NAV’s of Hdfc small cap fund for 6 years.

In addition, I have calculated the rate of return for every year, as you can see in the 3rd column.

After that, I have calculated the average return for this fund.

And the average return is 31.1%.

Let’s assume xi = 31.1% (average return).

 

You can see in the above image that “x” values are the yearly rate of return from the HDFC small cap fund from January 2020 to jan 2025.

Now, we need to calculate “(x-xi), i.e., we need to subtract average return “xi” from yearly returns.

In addition, (x-xi) values, you can see in the 2nd column.

Let’s assume (x-xi) = x1.

In order to calculate the variance, we need to calculate “x1^2” for all x1 values.

Now, you need to add all x1^2 values and divide by 5.

As number data points in our case study are 5 to arrive at variance.

And the variance value in the image is 5%.

Now we need to calculate the standard deviation using variance.

And SD is nothing but the square root of variance.

Hence, applying square root to the variance, the standard deviation for the HDFC small cap fund for yearly returns is 21.38%.

Now, we know that the average return is 31.1% and the SD is 21.38% for the HDFC small cap fund.

Apply the standard deviation and analyse volatility for HDFC Small Fund…

What is a standard deviation? …

SD is a statistical measure that will tell us how much the price will move away from its mean (average) due to volatility.

In our case study, the mean is 31.1% and SD is 21.38%.

Let’s see how much extra ROI to 31.1% or how much lesser ROI to 31.1% we will get in different trending markets.

In uptrend markets…

In uptrend markets, a Hdfc small-cap fund may give a mean plus average return.

That means the return in uptrend markets for the HDFC small-cap fund will be 31.1% + 21.38%. = 52.58%

In Downtrend Markets…

In downtrend markets, this fund may give a mean minus average return.

That means the return in downtrend markets for this fund will be 31.1% minus 21.38% = 9.73%.

Here, you can see there is a huge variation from 9.73% to 52.58% for the HDFC small fund.

In addition, this variation of returns is called volatility.

Finally, as the variation is big, we can call that volatility in the HDFC small-cap fund very high.

And you may buy this fund when the ROI from the last year is showing 9% and sell this fund when the ROI is showing 52%.

If you apply the same SD formulas for a nifty 50 index fund, the volatility will definitely be much lesser than that of the fund we have done in this article.

However, it may be noted the sample data we took is only for 5 years for this.

And for a better analysis for measuring volatility in investment, its better for you to take a larger sample of data.

Moreover, don’t stop your research with SD only.

You may need to do some more analysis before making an investment decision.

Read the article about Silly Mistakes to Be Avoided in Investments.

Also, read the article about Standard Deviation: All You Need to Know…

And read about debt fund types after Sebi categorisation.

Also read about the Chits Fund: How much profit will you get from it?.

And read about the empirical rule: All you need to know…

Also read about Nifty 50—what is the best time to buy and sell? …

And read about gold investment—what is the best time to buy and sell? …