Most natural risk-takers mountain climbers, extreme athletes, motorcycle daredevils tend to talk about the high of a job well done, an adventure completed, a successful free fall, and so on. They're less likely to dwell on bones broken, damaged equipment, and the heavy insurance costs that surely dog them.
Investors tend to behave a little like these extreme athletes, at least when they're starting out: They would much rather talk about the returns their funds generated than the risks they took to achieve those returns or the losses they've incurred. Take the large-cap Cambiar Opportunity Fund for example. This fairly concentrated fund landed in the top 10% of its category in 2001-2004, but reversed course in 2007 and 2008, landing in the category's worst 5% and 25% respectively, before returning to its winning ways in 2009 and 2010. Tremendous gains are won only through tremendous risk taking, which often means many ups and downs in short-term returns. That's called volatility.
While no single risk measure can predict with 100% accuracy how volatile a fund will be in the future, studies have shown that past risk is a pretty good indicator of future risk. In other words, if a fund has been volatile in the past, it's likely to be volatile in the future.
In this lesson, we'll tackle two common yardsticks for measuring a mutual fund's risk: standard deviation and beta. Both of these measures appear on a fund's Morningstar fund report page.
Standard Deviation >>