Standard Deviation

How to measure if an investment is jumpy or steady

Understanding standard deviation as a simple way to measure investment risk
Modified

September 7, 2025

Category: Risk Management
Difficulty: Beginner

Definition

A number that tells you how much an investment’s returns bounce around. Higher number = more bouncy (risky). Lower number = more steady (safer).

The Simple Concept

Think of it like measuring bumpiness: - Smooth highway = low standard deviation = steady returns - Bumpy dirt road = high standard deviation = jumpy returns

In investing: - Low standard deviation = Returns stay close to average - High standard deviation = Returns swing wildly up and down

What the Numbers Mean

Typical Standard Deviations

Cash and savings: 0-2% - Very steady, almost no ups and downs

Government bonds: 3-8%
- Fairly steady, small ups and downs

Large company stocks: 10-20% - Moderate jumpiness, typical for stocks

Small company stocks: 20-30%+ - Very jumpy, big ups and downs

Cryptocurrency: 50-100%+ - Extremely jumpy, huge swings

The 68-95 Rule

Simple way to understand what standard deviation means:

If an investment has:

  • 10% average return
  • 15% standard deviation

Then about:

  • 68% of the time: Returns will be between -5% and +25% (10% ± 15%)
  • 95% of the time: Returns will be between -20% and +40% (10% ± 30%)

Translation: Most years you’ll make between -5% and +25%, but occasionally you might lose 20% or gain 40%.

Real Examples

Steady Investment

Government bond fund: - Average return: 4% per year - Standard deviation: 5% - Typical range: -1% to +9% most years - Extreme range: -6% to +14% in rare years

Jumpy Investment

Small company stock fund: - Average return: 10% per year - Standard deviation: 25% - Typical range: -15% to +35% most years - Extreme range: -40% to +60% in rare years

Why Standard Deviation Matters

For Choosing Investments

  • High risk tolerance: Can handle high standard deviation for higher returns
  • Low risk tolerance: Need low standard deviation for peace of mind
  • Time horizon: Long-term investors can handle more jumpiness

For Portfolio Building

  • Mix investments: Combine high and low standard deviation investments
  • Age consideration: Younger people can handle higher standard deviation
  • Goal matching: Match investment jumpiness to when you need money

Standard Deviation by Investment Type

Super Steady (0-5%)

  • Savings accounts
  • CDs
  • Money market funds
  • Short-term government bonds

Fairly Steady (5-15%)

  • Long-term government bonds
  • High-quality corporate bonds
  • Balanced mutual funds
  • Conservative allocation funds

Moderately Jumpy (15-25%)

  • Large company stocks (S&P 500)
  • Total stock market funds
  • Dividend-focused funds
  • International developed market stocks

Very Jumpy (25%+)

  • Small company stocks
  • Emerging market stocks
  • Individual stocks
  • Sector-specific funds
  • Cryptocurrency

Using Standard Deviation in Practice

Investment Selection

Questions to ask: - Can I handle this much jumpiness? - Does this match my time horizon? - Am I getting paid enough (higher return) for this risk? - How does this fit with my other investments?

Portfolio Level

Your total portfolio standard deviation depends on: - What investments you own - How much of each investment - How they move together (correlation) - Your overall mix of jumpy vs. steady investments

Common Mistakes

Ignoring Standard Deviation

  • Buying investments only based on past returns
  • Not considering how jumpy the ride will be
  • Being surprised by normal volatility
  • Panicking when normal ups and downs happen

Misunderstanding the Numbers

  • Thinking standard deviation predicts exactly what will happen
  • Expecting returns to always fall in the normal range
  • Forgetting about extreme events outside the typical range
  • Using standard deviation as the only risk measure

Simple Guidelines

Match Standard Deviation to Your Situation

Short-term goals (1-3 years) - Use investments with standard deviation under 5% - Examples: CDs, savings, short-term bonds - Can’t afford jumpiness when you need money soon

Medium-term goals (3-10 years) - Standard deviation of 5-15% okay - Mix of stocks and bonds - Some jumpiness acceptable

Long-term goals (10+ years) - Can handle standard deviation of 15-25% - Mostly stocks for growth - Time to ride out the jumpiness

Age-Based Rules

  • Young (20s-30s): Can handle 15-25% standard deviation
  • Middle-aged (40s-50s): Reduce to 10-20% standard deviation
  • Near retirement (60s+): Lower to 5-15% standard deviation

The Bottom Line

Standard deviation is just a way to measure how jumpy an investment is. Higher numbers mean more risk but usually higher potential returns.

Key points: 1. Know what you’re getting into - understand the jumpiness 2. Match it to your situation - time horizon and risk tolerance
3. Don’t be surprised - normal ups and downs are normal 4. Use it as one factor - not the only thing that matters

Remember: You generally need to accept some jumpiness to get decent returns over time.

External Resources