We all remember teachers we had who made significant impacts on education and our lives.
I recall one math teacher who had the uncanny knack of proclaiming the most mundane and obvious statements as though he had an epiphany. For instance, we were touching on statistics one day and he simply declared, “MATH IS FUN.” The class kind of looked at each other and in a manner of cultish-like hypnotism, we all nodded in sincere agreement.
Of course, we finished out the class documenting the difference between mean, median and mode knowing one day we’ll have tremendous enjoyment when we find something in which it would be applicable.
Fast forward to present day — I bring you standard deviation. What is standard deviation? The basic definition of standard deviation is a measure of the amount of variation or dispersion on a set of values.
Baseball is a great example of applied statistics and the use of standard deviation to determine the strength of a player or position.
Here, in any given category like batting average, fielding, slugging, etc., analysts can find the average (mean) for each category across the MLB or given position. For batting average let’s assume the MLB average is .250. This number is found by sampling adding up all the batting averages, and dividing that number by the number of batters.
The variance is calculated by squaring the difference on all batting percentages on either side of the average of .250, and again dividing that by the number of batters. One would then take the square root of that number to find the standard deviation. In this case it might be +/- (plus/minus) .030, meaning the lower-end could be around .220, while the higher average might be around .280.
So, in essence the average is .250 and a greater number of batters will fall within the .220-.280 category. Those who hit above .280 would be considered to excel and those below the .220 range, underperforming. Of course there are other variables at play, which is why there are other measurements on how it might complement the team. However, the math provides a statistical basis on which analysts and managers can make a decision.
When investing, standard deviation provides a foundation for investment managers, investors and economists to determine market volatility, or risk on a particular investment. Typically the higher standard deviations from the average return on the investment indicates a greater amount of volatility. And, of course, the lower standard deviation – less movement away from the average — expresses lower volatility.
Said another way, larger standard deviations from the normal or average return indicate a greater possibility of different outcomes which can positively or negatively impact the return with an enhanced degree of uncertainty. This is why when managing money, one has to really focus on the objective or goal those funds are allocated for at the time.
Emergency funds should really be in cash and or CDs, carrying a standard deviation which essentially amounts to zero, as in no risk. A portfolio for retirement in regards to a 30-year old would likely carry a higher standard deviation than an individual in retirement as their goals and risk relative to market returns are likely reflective of different goals (i.e. appreciation vs. preservation and income).
This tool of measurement is by no means the end-all answer to building a portfolio, but a useful tool in determining risk in a portfolio. There are many other measures investors can use to assess whether an investment is too risky – or maybe not enough. And to clarify, risk is not a bad thing as with most things the greater the risk the greater the potential reward. But, as a matter of calculation and understanding it is important to ultimately gauge the age-old dilemma — is the risk worth the reward?
If trying to better understand the answer to that question, especially as it relates to investment and financial planning, it might be helpful to seek the advice of a trusted professional. In providing an honest assessment of your risk tolerance, professionals can assist in building a plan to address your objectives and planning needs.
With that, I’ll end with a quote on baseball statistics from the great commentator Vin Scully, “Statistics are used much like a drunk uses a lamppost: For support, not illumination.”
Play ball and have a great summer.
Securities and advisory services are offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL Financial or its licensed affiliates. Dupaco Community Credit Union and Dupaco Financial Services are not registered as a broker-dealer or investment adviser. Registered representatives of LPL offer products and services using Dupaco Financial Services, and may also be employees of Dupaco Community Credit Union.