The higher the dispersion, the riskier it is to invest in that particular security. Imagine you had to choose to buy one of two securities—the one we’ve just covered and another with a similar annualized return of 5.4%:
By determining the standard deviation for security 2, you can make an informed decision on which of the two securities to add to your portfolio.
The comparison shows that security 1 is more volatile than security 2, although they have identical values in terms of annualized return.
Along with annualized total return, the standard deviation indicates the historical volatility of a security. For example, two stocks with the
same average return
can have
different standard deviations,
indicating which investment option to go for.