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Standard deviation is one of those terms that can be instant roadblocks to those just getting into investing. However, you need not hit the brakes or turn back – this guide can help you rumble on full speed ahead with a basic understanding of what standard deviation is all about and why it matters.

Standard Deviation 101

For the uninitiated, standard deviation is a statistical measurement that accounts for a dataset’s dispersion relative to the mean, achieving this by being calculated as the square root of the variance.

Put into plain English, the further data points on a graph are from the mean, the higher the deviation exists within the dataset, which in turn means a higher standard deviation.

Why This Matters

Think of standard deviation-influenced investing such as building a baseball team. Investing in batters who hit home runs 1/6 of the time but make outs 5/6 of the time will lead to an extremely boom-or-bust team, with the latter more common. This kind of team is highly risky and unlikely to win. However, investing in players who hit singles and doubles at a 1/3 clip may not be as flashy as getting home run hitters, but that consistency will likely lead to far better results.

The same goes for investing with standard deviation as your guide. Predictability and consistency are huge deals in financial investing, and funds that show a low standard deviation equate to more consistent and thus more trustworthy investments on average. By contrast, high standard deviation means a boom-or-bust stock.

Now, not all such high-risk stocks are bad, just like not all home run-or-strikeout hitters are bad. Good baseball teams have diverse lineups, and strong stock portfolios are likewise diversified. That said, in either case, consistency is the foundation from which all success is built.

Finally, it’s worth noting that standard deviation, such as home run versus strikeout ratios in baseball, aren’t a be-all end-all for successful investing. For example, standard deviation only shows dispersal of annual returns for a given year or years, which does not in and of itself guarantee future consistency. Furthermore, this method has limits in terms of measuring stocks and funds just in terms of annual returns and consistency.

Even so, mastering standard deviation is essential for scoring stock and mutual fund investment wins.