Explain Standard Deviation - as you would to a 10 year old.
Standard Deviation is a measure of Risk in Finance.
But what does it really mean?
Let’s first understand the importance of Standard Deviation.
Take an example from Cricket.
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Standard Deviation is a measure of Risk in Finance.
But what does it really mean?
Let’s first understand the importance of Standard Deviation.
Take an example from Cricket.
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Let’s take Rishabh Pant and Pujara.
Assume their scores in 4 innings are
Pujara: 50, 50, 50, 50
Pant: 100, 0, 100, 0
Note the average is the same: 50 in both the cases. The expected outcome is a score of 50.
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Assume their scores in 4 innings are
Pujara: 50, 50, 50, 50
Pant: 100, 0, 100, 0
Note the average is the same: 50 in both the cases. The expected outcome is a score of 50.
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But the deviation from this expected outcome (standard deviation) is different.
Standard Deviation
Pujara: 0 (never deviates)
Pant: 50 (a 50 run deviation - either side)
And that is what defines the risk.
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Standard Deviation
Pujara: 0 (never deviates)
Pant: 50 (a 50 run deviation - either side)
And that is what defines the risk.
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Think about it
If you want someone to bat for your life, who would it be? Pujara for sure. Maybe boring, but reliable.
If you want entertainment, you would choose Pant. Risky, but entertaining.
And that is what Standard Deviation tells us about investments.
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If you want someone to bat for your life, who would it be? Pujara for sure. Maybe boring, but reliable.
If you want entertainment, you would choose Pant. Risky, but entertaining.
And that is what Standard Deviation tells us about investments.
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If you want an investment to give you reliable returns, with little volatility, you choose something with low Standard Deviation. Investments for Retirement, Education of Kids etc would fall in this bracket, especially if the goal is near.
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If you want to generally take some risk to maximize the return, and are fine with volatility, you pick investments with higher Standard Deviation. Investments for aspirational goals such as an extra foreign vacation, or a higher end car would usually come under this.
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Extending to stocks, we need to incorporate some concepts from Normal Distribution (But more on this some other day)
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