Is Your Mutual Fund Taking Too Much Risk?
Some key measures can give you a good approximation.
In 2008, many investors felt like they had nowhere to hide. Investment types that many investors thought might offer shelter during inclement weather for the stock market--such as bond funds and commodities--posted painful losses. Such blowups highlight the facts that investing comes with risks and that some investments are riskier than others. Identifying those risks, in addition to figuring out how much you're willing to tolerate, is one of the most important aspects of long-term investing.
Unfortunately, there's no single definition of risk that works for everybody, but there are some key measures that will usually give you a good approximation. They're not perfect--there are often hidden risks lurking--but they're certainly better than guesswork. In last week's column, Katie Rushkewicz detailed how Morningstar's new Chart feature can help you size up how volatile a fund has been in the past. Here are some other ways of looking at mutual fund risk and volatility.
Backward-Looking Risk Measures
The world of finance is replete with measures that try to gauge how risky an investment has been in the past. In this context, risk is often equated with volatility, and the most common way to measure the volatility of a mutual fund (or any portfolio) is standard deviation. As Morningstar calculates it, this measures how widely the fund's monthly returns have varied over some period of time, usually three, five, or 10 years. If monthly returns have been very consistent, the standard deviation will be low, while if they have been all over the map, the standard deviation will be high. (You can find more about the details of our methodology in this document, and you can find any fund's three-year standard deviation on its Risk Measures page on Morningstar.com.)
David Kathman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.