Category : Investing Guides September 18, 20255 minutes read
Volatility in mutual funds refers to the degree of price fluctuations in a scheme that is influenced by factors like market sentiment, economic changes, and interest rate movements. It affects mutual fund performance and can be measured through methods such as standard deviation and beta. Understanding historical and implied volatility helps investors assess risk, while strategies like diversification, financial planning, investing in low-risk funds, and systematic investment plans (SIPs) can help manage it. Key measures like the Volatility Index (VIX) and Beta further aid in evaluating and navigating market volatility.
Volatility means the degree of variation in the price of a financial asset over time — high volatility means prices move sharply up or down, while low volatility means prices stay relatively more stable.
Factors causing volatility in mutual funds:
- Market Sentiment: Investor emotions like fear or greed can cause sudden buying or selling, leading to sharp price changes.
- Macroeconomic Factors: Events like inflation data, unemployment rates, or political instability impact market confidence and cause price swings.
- Interest Rates: Changes in interest rates affect borrowing costs and investment returns, often leading to big market movements.
This guide will explore the concept of volatility in mutual funds, explaining how fluctuations in asset prices can affect mutual fund performance. We will walk through volatility calculation methods and dive into different types of volatility, including historical volatility and implied volatility. Additionally, we will explore strategies for mitigating mutual fund volatility. Finally, the guide will introduce key measures of market volatility, including the Volatility Index (VIX), which tracks market expectations of near-term volatility, and Beta, which measures a fund’s sensitivity to market movements.
The degree of variation in a mutual fund’s Net Asset Value (NAV) over time is known as volatility, and it serves as a gauge of the investment’s degree of risk. Statistical techniques like standard deviation and beta, which evaluate the fund’s sensitivity to market fluctuations and return variability, respectively, are frequently used to measure it.
While a higher beta suggests that the fund’s performance is more sensitive to fluctuations in the market, a larger standard deviation shows greater volatility and suggests that the fund’s returns can deviate significantly from the average. There are several ways that volatility affects the performance of mutual funds. Significant short-term swings in the fund’s value due to high volatility may result in large gains or losses.
Furthermore, because of the “volatility tax,” which occurs when the geometric mean return is lower than the arithmetic mean return in the presence of changing returns, volatility can affect a mutual fund’s compound returns. This effect emphasises how crucial it is to take volatility into account when assessing a mutual fund’s long-term performance and fit for an investor’s portfolio.
Calculating Volatility in Mutual Funds
Volatility calculation measures the degree of variation in the price of a financial asset over a specific period. It is a key indicator of market risk and is commonly calculated using statistical methods such as standard deviation or variance of returns. Historical volatility analyses past price data to determine how much an asset’s price has fluctuated, while implied volatility, derived from options prices, reflects market expectations of future price movements.
Accurate volatility calculation is crucial for risk management, portfolio optimization, and pricing derivatives.
Make informed choices by understanding volatility and its impact on potential returns. Choose mutual funds suitable for your goals with Bandhan Mutual Fund.
Volatility in mutual funds refers to fluctuations in the fund's Net Asset Value (NAV) over time and indicates its level of investment risk. It is commonly measured using statistical tools like standard deviation and beta—standard deviation reflects variability in returns, while beta assesses sensitivity to market movements. High volatility can lead to large short-term gains or losses and impact long-term performance due to the “volatility tax,” where compounded returns are reduced. Volatility is calculated using historical or implied methods and is essential for risk management, pricing, and portfolio decisions, making it a key factor in evaluating a fund’s suitability for investors.
Volatility in mutual funds reflects how much the price of an asset fluctuates over time. There are two main types: Historical Volatility and Implied Volatility, each offering a different perspective on risk. Understanding both helps investors make better decisions about past performance and future expectations.
Historical Volatility
Based on actual historical prices, historical volatility quantifies the degree of price fluctuation of an asset over a given time period. It is computed by calculating the standard deviation of the returns on the asset over a given period of time, like the previous 30 or 90 days.
A higher historical volatility suggests that the asset had larger price movements in the past, whereas lower historical volatility signifies prices were generally constant. Investors use historical volatility to analyse how risky or stable an investment has been over time, but it does not foretell future moves – it merely represents the asset’s past behavior.
Implied Volatility
The market’s assessment of how much an asset’s price is anticipated to fluctuate in the future is known as implied volatility. Using methods like Black-Scholes, it is calculated from the pricing of options contracts rather than historical prices.
A high implied volatility indicates that the market anticipates significant price movements in the future (greater risk or uncertainty), frequently as a result of impending events like economic data releases or earnings announcements. On the other hand, a low implied volatility indicates that the market anticipates more consistent, minor price fluctuations. The price of options is also directly impacted by implied volatility; a greater IV raises the cost of options since it increases the likelihood that they will turn a profit due to the possibility of large swings.
Investors can effectively manage mutual fund volatility and work towards their financial goals with greater confidence by using four strategies—comprehensive financial planning, investing in low-risk funds, and investing via SIPs.
Diversification
Diversification is one of the most common ways to potentially mitigate volatility in mutual funds. To lower risk, portfolio diversification involves spreading investments across a range of industries, asset types, and regions. The impact of a downturn in any specific industry or asset class may be reduced by avoiding the concentration of investments in a single area. For example, a balanced portfolio that is more resistant to market swings may be created by mixing investments in debt, stock, and gold.
However, it is necessary to remember that market volatility cannot be completely eliminated; any mutual fund investment is always subject to market volatility.
Financial Planning
A well-structured financial plan connects investments with an individual’s risk tolerance, financial objectives, and time horizon. Understanding one’s risk tolerance and defining specific investment goals can help influence the selection of suitable mutual funds. Regularly monitoring and revising the investment portfolio keeps it in line with changing financial circumstances and market conditions. As a result, financial planning may help mitigate volatility in mutual fund investments.
Read more about the importance of financial planning.
Low Volatility Mutual Funds
Investing in low-risk or low volatility mutual funds may provide stability in tumultuous market conditions. These funds, also known as debt funds or arbitrage funds, invest largely in fixed-income securities such as government bonds or high-quality corporate debt, which provide relatively more predictable returns. They may be appropriate for conservative investors or those seeking short-term financial gains. By investing a portion of the portfolio to low-risk funds, investors may minimise overall portfolio volatility and protect themselves from large losses.
Systematic Investment Plans
Systematic Investment Plans (SIPs) include investing a fixed amount on a regular basis, independent of market conditions. This strategy encourages disciplined investing and employs rupee cost averaging, in which more units are acquired when prices are low and fewer when prices are high, hence lowering the average cost per unit over time. SIPs may reduce the risks associated with market timing while encouraging long-term wealth growth through continuous investing.
Diversity your portfolio by starting an SIP in mutual funds today! Unlock the potential benefits of diversification with Bandhan Mutual Fund.
Investors can manage mutual fund volatility and pursue financial goals through four key strategies: diversification, financial planning, low-risk funds, and Systematic Investment Plans (SIPs). Diversification spreads investments across industries, asset classes, and regions to reduce risk and cushion against market downturns. Financial planning aligns investments with personal goals, risk tolerance, and time horizon, ensuring regular portfolio reviews. Low-risk funds, like debt or arbitrage funds, offer relative stability and are suited for conservative investors. SIPs involve investing fixed amounts regularly, leveraging rupee cost averaging to smooth out market fluctuations. While volatility can’t be eliminated, these strategies help manage its impact effectively.
Both VIX and Beta are essential tools for investors to assess risk volatility in mutual funds. Assessing the volatility allows investors to make informed decisions and plan your finances accordingly.
Volatility Index
Based on S&P 500 index options, the VIX, also known as the “fear gauge,” gauges the market’s expectations of volatility over the following 30 days. Increased expected market volatility and investor uncertainty are indicated by a higher VIX value. For example, the VIX tends to increase during times of market stress, indicating increased investor anxiety.
Beta
A measure called beta contrasts the volatility of a stock with that of the market as a whole. A stock is more volatile than the market if its beta is more than 1, and less volatile if its beta is less than 1. A beta of 1.2, for instance, indicates that the stock should be 20% more volatile than the market.
- Volatility refers to the degree of variation in the price of a financial asset over time – higher the volatility, higher the change.
- Market sentiment, macroeconomic factors such as inflation, and changes in interest rate can cause volatility in the market.
- There are two types of volatility – historical and implied volatility in mutual funds.
- Investors may mitigate volatility by diversifying their portfolio, planning their finances, investing in low risk funds, and investing through Systematic Investment Plans (SIPs).
- Volatility in mutual funds can be measured through a volatility index and beta.
