Researching Funds Through the Internet
Step 3: Which Risk Statistics Will I Find Online?
Glance at any site on your computer screen and your eye is usually drawn first to returns. But you should force yourself to stare at risk measures for more than a passing moment.
Many of the sites offer detailed measures of risk—some esoteric, some basic. The question to be answered, however, is how volatile the returns on a fund are likely to be, both absolutely and compared to similar funds and market benchmarks. The greater the risks you take, the better the returns should be.
Here is a primer on the risk statistics you can access.
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Standard deviation—A measure of total absolute volatility of a fund's return no matter what the source. The larger the number, the greater the risk. This figure should be compared against other funds and an index benchmark, if possible.
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Beta—A measure of relative volatility of return compared to a benchmark. A beta of 1.00 means the volatility of the fund is equal to the volatility of the benchmark; for example, a 0.50 beta would be half as volatile as the benchmark, and a 1.50 beta would be 50% more volatile. This risk measure looks only at market risk and is useful only for well-diversified stock funds, not sector funds.
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Alpha—A measure of the fund return above or below what the fund should have achieved given its risk level. Positive alphas are good, negative alphas are bad.
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R-squared—A measure of return correlation with the overall market or some relevant benchmark. R-squared can range from zero to 100, and it reveals the percentage of the total return variation that is explained by movements in the overall market. A high R-squared implies that a fund is well-diversified and the beta risk measure is therefore meaningful; a low R-squared indicates a sector fund or a concentrated fund and its beta is likely to be less meaningful.
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Sharpe Ratio—This ratio measures the return relative to risk, as indicated by the standard deviation; the higher, the better. The Sharpe Ratio is most useful when it is compared to other funds in the same category or some broad-based benchmark index.
Pick your risk measures, but no matter what, you need to gain an intuitive feel for how risky your fund is compared to other funds and the overall stock or bond market.
Continue to Step 4 »
