Question

11. What are the two main reasons using Standard Deviation to quantify a portfolio’s risk can be misleading or worse?

Answer 1

Standard Deviation as a measure is not very reliable because of the following reasons:

1. It is not very forward looking, mostly based on historical performance. SD indicates how the investment returns are spread out but the outcome may not be consistent in future. Investment may be affected by various factors and the annual return may fall outside a predicted range.

2. Standard Deviation assumes a normal distribution and uniform probability which is not true for many investments. SD does not seperate upside and downside volatility. A high growth rate will also show a high SD and a losses will also show a high SD. So there is no seperation of upside and downside variance.