Understanding Volatility (Not Congressman Weiner)

risk and rewardIt could be a colleague, a friend—even your mom—but you probably know someone whose capricious whims or moods drive you nuts.

That same volatility, or hard-to-predict quality, can make certain investments hard to handle.

Volatility refers to the rate at which the price of a security fluctuates, both over time and relative to other, similar investments.

Isn’t the name of the game to reduce volatility to a minimum?

Well, take that up-and-down colleague of yours. She zigs, she zags—but those lightning flashes often spark smart solutions (and boy, can she rev up a party).

By the same token, volatile investments can be risky. But sometimes that extra risk can power a higher return.

Here are four common measures that can help you decide whether a fund’s volatility is worth it:

Standard deviation: How much a fund’s return fluctuates over time
Beta: How much the return varies from the fund’s index (benchmark)
R-squared: A measure that determines whether you’re measuring beta against the right index
Alpha: How much higher of a return are you getting, given the risk?

If you’d like to read more about how these four intersect, here’s a nice, clear primer from Investopedia.

Go crazy. What’s your most volatile investment (besides your spouse)?

Tagged in: Investing, MP Dunleavey