One of the most common questions I get in the office is how to determine a rate of return on investments. This is because the more it’s measured, the more likely it is that some of it is a wash, especially with stock market investments.
I get a lot of questions regarding rate of return. This is because it is one of the most important, and least understood, components of finance. There are a variety of approaches to measuring the rate of return, but the simplest and most widely used is known as the “standard deviation.” It’s simply the square root of the variance.
The standard deviation is a way to measure the variance of a random variable. In other words, it measures how spread out the sample values are. This is what is used in most standard deviation formulas such as the standard deviation of the returns of a stock market portfolio. The standard deviation of the returns of a stock market portfolio is the square root of the variance.
The variance of a stock market portfolio is an indicator for the riskiness of a given stock market portfolio. The more spread out the returns of a stock market portfolio, the more risky it is. And in turn the more riskier the stock market portfolio. A stock market portfolio that has a standard deviation of 0.50 is very risk free, but a standard deviation of 0.52 is more risky.
In a stock market portfolio, the standard deviation is the amount of risk that you can’t afford to own a particular stock. If your portfolio has a standard deviation of 0.50, then that means the riskiest (most risky) of your stocks is worth 0.50 (in the same way as a stock with a 0.3 standard deviation is more risky than a stock with a 0.2 standard deviation).
The standard deviation of returns is a measure of how risky a given company is. It is used here because the term “risky” is used generally in finance and in the context of investing.
The reason standard deviation is used is because it measures the volatility of a given stock. For example, if a stock is most risky to own in a given year, then its volatility is higher than the average and therefore its volatility is a more important factor in determining the company’s value.
Standard deviation is the standard deviation of the return of a stock, not its return value. So if the standard deviation is 0.2 the company would be most risky.
On average, if a stock’s return is 5% for every year it’s been in existence, its volatility is 4% and therefore its volatility is a much more important factor in determining its worth. For example, if a stock has a volatility of 4% then it’s also more risky than its normal return of 5% for every year it’s been in existence.
The company’s cost of return is its ability to take out the entire stock and then return the company’s profit to its shareholders. That’s how a company like this works.