If you are an investor in mutual funds, you may have heard of the term annual volatility. But what does it mean and how can it help you review your portfolio performance? In this blog post, we will explain the concept of annual volatility and how you can use it to assess the risk and return of your mutual fund investments.
Annual volatility is a measure of how much the returns of a mutual fund fluctuate over a year. It is calculated by taking the standard deviation of the monthly returns and multiplying it by the square root of 12. The higher the annual volatility, the more unpredictable the returns are and the more risk you are taking as an investor.
Why is annual volatility important? Because it helps you compare different mutual funds based on their risk-adjusted returns. Risk-adjusted returns are the returns that a mutual fund generates per unit of risk taken. A common way to measure risk-adjusted returns is by using the Sharpe ratio, which is the ratio of the excess return (the return above the risk-free rate) to the annual volatility. The higher the Sharpe ratio, the better the performance of the mutual fund relative to its risk level.
By looking at the annual volatility and the Sharpe ratio of different mutual funds, you can evaluate how well they are performing in relation to their peers and to your risk tolerance. For example, if you are a conservative investor who prefers low-risk investments, you may want to choose a mutual fund that has a low annual volatility and a high Sharpe ratio. On the other hand, if you are an aggressive investor who seeks high returns and can tolerate high risk, you may opt for a mutual fund that has a high annual volatility and a high Sharpe ratio.
However, annual volatility is not the only factor that you should consider when reviewing your portfolio performance. You should also look at other aspects such as the fund’s objectives, strategy, fees, diversification, consistency, and track record. Annual volatility is just one tool that can help you make informed decisions about your mutual fund investments.