Investing in mutual funds is one of the most popular ways to build wealth over the long term. However, like any investment, mutual funds come with their share of risks. It is essential to understand and assess these risks to make informed investment decisions. This article aims to shed light on some of the key risk assessment tools for mutual funds - standard deviation, semi-deviation, value at risk, average drawdown, and maximum drawdown. The calculated values of all these risk parameters are available on the website.
Standard deviation is a measure of volatility or the extent to which the returns of a mutual fund can vary from its average return. It helps investors understand the risk associated with a mutual fund and how its returns might fluctuate over time.
A high standard deviation indicates a high degree of volatility, suggesting that the fund's returns can significantly deviate from the average. Conversely, a low standard deviation indicates lower volatility, implying that the fund's returns are likely to stay close to the average. As a rule of thumb, risk-averse investors should consider funds with lower standard deviations.
You Can Read More Here: Tools To Calculate Risk In Mutual Fund: Standard Deviation
While standard deviation considers both upward and downward volatility, semi-deviation only focuses on the downside. It measures the variability of returns below a certain target or minimum acceptable return.
Semi-deviation is a useful measure for investors who are more concerned about potential losses rather than gains. A high semi-deviation indicates that the negative returns have been more volatile, and there's a greater risk of the investment performing below the target. Conversely, a low semi-deviation suggests that the fund has had smaller fluctuations on the downside, potentially making it a safer bet for risk-averse investors.
You Can Read More Here: Tools To Calculate Risk In Mutual Fund: Semi Deviation
VaR is a statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over a specific time frame. It estimates the maximum loss that a portfolio could suffer in a given time period under normal market conditions at a certain confidence level. For example, a VaR of 5% over one day at a 95% confidence level means that there is a 5% chance that the portfolio will fall in value by 5% or more in a single day.
While VaR is a robust risk measure, it does have its limitations. It assumes normal market conditions and ignores losses that occur beyond the confidence level.
You Can Read More About VaR Here
Average drawdown refers to the average of all drawdowns, which are the declines in value from a peak to a trough over a specified period. It provides investors an idea about the average loss they can expect from peak to trough while holding a mutual fund.
A higher average drawdown indicates more significant average declines, signaling higher risk, while a lower average drawdown implies smaller average drops, indicating lower risk.
You Can Read More Here: Tools To Calculate Risk In Mutual Fund: Average Drawdown
Maximum drawdown is the largest single drop from peak to trough for a mutual fund, regardless of the time period. It represents the worst possible loss an investor could have experienced if they bought at the highest point and sold at the lowest point.
A higher maximum drawdown indicates that a mutual fund has experienced significant declines in the past, which can be a warning sign for risk-averse investors. Conversely, a lower maximum drawdown suggests that the fund has been relatively stable and less likely to have significant drops.
In conclusion, mutual fund investments require careful risk assessment. Tools like standard deviation, semi-deviation, value at risk, average drawdown, and maximum drawdown can provide valuable insights into a fund's risk profile. However, these should not be used in isolation and need to be considered in conjunction with other factors like the fund's investment objective, the investor's risk tolerance, and the overall market conditions. As with any investment, it's always a good idea to consult with a financial advisor or conduct thorough research before making any investment decisions.