When discussing high-return investment options beyond traditional methods, mutual funds often come up. However, since mutual fund investments are linked to market risks, it is crucial to understand these risks before investing.
The risks associated with mutual funds vary depending on the type of fund. As an investor, it is essential to be aware of these risks. Fortunately, there are several methods to evaluate and measure the risks in mutual fund investments.
Key Metrics to Measure Mutual Fund Risk
Several factors influence the risk associated with a mutual fund, including changes in the economy, interest rates, geopolitical conditions, and company management. These factors contribute to the overall risk of the fund. Understanding and measuring this risk is essential when analyzing and selecting funds. Below are some key metrics to help you assess mutual fund risk:
1. Beta: How Much a Fund’s Value Moves with the Market
Beta shows how much a fund’s value changes compared to the market or its benchmark.
- Beta = 1: The fund’s value moves the same as the market.
- Beta < 1: The fund is less sensitive to market changes.
- Beta > 1: The fund is more sensitive to market changes.
If you want less risk, choose a fund with a low beta.
2. R-Squared: How Close a Fund Follows the Market
R-squared measures how closely a fund’s performance follows its benchmark, on a scale from 0 to 100.
- High R-squared: The fund closely matches the market.
- Low R-squared: The fund has less connection to the market.
This helps you pick a fund based on how much it aligns with market performance.
3. Standard Deviation: How Much a Fund’s Returns Fluctuate
The standard deviation shows how much a fund’s return may vary from its average.
- Example: If a fund’s average return is 13% with a standard deviation of 2%, its actual return could range between 11% and 15%.
- A higher standard deviation means more ups and downs in returns.
4. Sharpe Ratio: Is the Return Worth the Risk?
The Sharpe Ratio shows whether a fund’s high returns come from smart decisions or high risks.
- It compares the fund’s return with its risk.
- A higher Sharpe ratio means better returns for the amount of risk taken.
Use this to compare funds and choose the one with better risk-adjusted returns.