Four tools to calculate risk in mutual fund investment
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Even though mutual funds offer a great deal of sanity by minimising the risk due to the diversification of the investments, but there are still some risks involved. Listening to this, one could easily cast his/her mind to the television ads that read “Mutual fund investments are subject to market risk. Please read the offer document carefully before investing”. Like stocks, mutual funds also carry a fair amount of risk. So, it is vital you assess the risk profile of your mutual fund carefully so that you could investing in this medium for a long time. Here are some of the tools that you can use to assess the risk and fluctuation in your mutual fund.
Beta, a commonly used risk measurement solution, compares the volatility of a mutual fund with that of a benchmark. It is expected to provide you a clue on the extent to which fund can fall when the market nosedives, or the rise when the bull gains steam. A fund having a beta more than 1 is construed to be more volatile than the market. While beta less than 1 is considered less volatile. If your fund has a beta of 1.20, then it exemplifies that the fund has fluctuated 20% more than the benchmark on the upswing of the market. It should perform better by 15%. On the market downfall, it should plunge by 15% more.
Alpha evaluates the relationship between the historical beta and the existing performance of the fund. An alpha with zero value means that the performance of the fund was on expected lines taking into account the risks it had taken. A positive alpha signifies that the fund has returned more than the projection of beta, while a negative alpha means it has returned less.
Standard Deviation, a popular risk measurement tool, is used for measuring the difference of fund’s recent numbers from the long-term average. For instance-if your fund offers an average rate of return at 15% and has a standard deviation of 8%, then the return will range within 8%-23%. A higher standard deviation indicates a comparatively more risky fund than the one with lesser standard deviation. But, you should not go by the number alone as you need to compare the standard deviation of your fund with that of a competing one.
Sharpe Ratio, conceptualised by Nobel Laureate Bill Sharpe, aims to measure the performance of fund in relation to the risks it take. You can calculate Sharpe Ratio by dividing the returns of fund above an assured investment by the standard deviation of the returns. The fund’s performance will be viewed better if the Sharpe Ratio is bigger. You have to compare the Sharpe Ratio of your fund with that of another fund to get the more precise risk calculation.
Hope you would have got to know about the tools to assess the risk involved in your mutual fund investment. Take this into account while investing in a mutual fund to remain on the safe path.