What is Risk and Standard Deviation?

Risk and Return.

TrafficLet us imagine the markets like highway driving. All lanes go to the same place. It’s just a matter of how fast, or slow, you want to go to get there. Faster lanes arrive sooner, but have a higher risk that something happens and you end up getting there later than a slower lane. Slower lanes arrive later. There may be people zooming by in the other lanes, but they are also more exposes to potential risks. Portfolio allocation helps determine the level of risk you are comfortable with, a similar choice as to which lane you choose to drive in. Often times on the highway, you have no choice when something happens up ahead … markets and economies also have things happen that are beyond your control as well.

Standard Deviation (or Volatility)

Imagine you are walking or biking along a curvy mountain trail together with your teenage son and elderly mother. One side of the trail is a sheer drop; the other side is the solid face of the mountain.

EdgeThe teen may enjoy running to the edge on one side of the path and looking down at the river below, and climbing up the side of the mountain on the other side of the path to get a different view.

Your elderly mother most likely will hug the face of the mountain and not deviate too far from the intended path right next to the side of the mountain.

The more you deviate from the path, the more volatile the results … in other words, the higher the

standard deviation, the more you have strayed from the intended path.

, , ,

Trackbacks/Pingbacks

  1. How scared should you get? | Better Financial Education Blog - May 9, 2012

    […] Another blog about risk.  Returns are less important than contributions (withdrawals) …which means you should focus more on how much you save before you retire (or withdrawal once you retire). […]

Leave a Reply