Series 65: Standard Deviation

Taken from our Series 65 Online Guide

Standard Deviation

Investors use standard deviation (SD) to measure the variability of a security’s returns. For example, if a stock’s price fluctuates greatly over time, its returns will show a high standard deviation, meaning greater risk to the investor. Securities with high standard deviations tend to have higher expected returns (and yields), because the market requires compensation for greater risk.

A security with a higher standard deviation has a greater probability of high or low returns than a security with a lower standard deviation. Thus, a high standard deviation means more risk for the investor.

In the example below, even though Securities A and B have the same average return of 4.4%, Security A has a higher standard deviation than Security B. In fact, an investor can expect to see the returns on Security A varying on average by 10.8%, but the returns of Security B should vary less than 1%. This makes Security A a much riskier investment than Security B.

Year 1

Year 2

Year 3

Year 4

Year 5

Average

SD

Security A

3%

7%

-10%

2%

20%

4.4%

10.8%

While it is relatively easy to calculate the standard deviation from the historical returns of a single security, it is much more difficult to calc

Since you're reading about Series 65: Standard Deviation, you might also be interested in:

Solomon Exam Prep Study Materials for the Series 65
Please Enable Javascript
to view this content!