Measuring and Managing Portfolio Risk

Standard deviation measures how much an investment's returns vary from its average. The S&P 500 has a long-term standard deviation of approximately 15 percent with an average annual return of 10 percent. This means returns fall within one standard deviation (negative 5 percent to positive 25 percent) about 68 percent of the time, and within two standard deviations (negative 20 percent to positive 40 percent) about 95 percent of the time. Bonds have a standard deviation of 5-7 percent. A 60/40 portfolio has a standard deviation of approximately 10 percent. Understanding volatility helps set realistic expectations—a 15 percent standard deviation means 30+ percent drops are not rare, they are statistically expected events.