Portfolio volatilitystandard deviation of returns

Volatility describes how much a portfolio’s returns fluctuate around their average. A portfolio that moves a fraction of a percent each day has low volatility. One that can gain 3% one day and lose 4% the next has high volatility. Volatility is the most popular, though not the only, measure of investment risk.

How it is calculated

Volatility is typically the standard deviation of returns over a chosen window, e.g. daily returns over the last 30 days. Daily volatility is annualized by multiplying it by the square root of the number of periods in a year:

The number 252 is the approximate number of trading sessions in a year. Example: a daily volatility of 1% corresponds to roughly 15.9% a year. Volatility should be calculated from returns that exclude deposits and withdrawals (like TWR), otherwise a top-up would look like a sharp rise.

How to read volatility

• Higher volatility means a wider range of possible outcomes, both up and down.
• Volatility treats rises and falls alike, while investors usually only worry about falls. Drawdown complements it.
• Volatility is not constant: it rises in crises and falls in calm periods.
• Diversifying across weakly correlated assets lowers the volatility of the whole portfolio.