Measuring Risk in Mutual Funds

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Measuring Risk in Mutual Funds

Daniel Cross May 20, 2016



In order to analyze mutual funds properly, risk ratios need to be examined to determine how volatile they are. Key indicators like alpha, beta, R2, and standard deviation can help investors find mutual funds that match their risk tolerance and let them know how safe they’re return predictions will be.


Alpha


This tells investors how much better or worse the fund does relative to the index itself. It’s also a gauge of how good the management of the fund is. Alpha is read as a percentage so an alpha of 1 means the fund outperformed its benchmark by 1%.


Beta


If a fund has a beta of 1, that means its performance will perfectly match the performance of the benchmark index. More than 1 means the fund will move in a direction greater than the index – up or down. Anything less than 1 and the fund will mark a lesser movement than the index. Some funds may even have a negative beta which tells you its performance is inversely correlated with the index.


R2


R2 also helps investors get a clearer understanding of a fund’s beta. The higher the R2, the more accurate a fund’s beta is likely to be.


Standard Deviation



Bottom Line


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