At first glance, it might be hard to understand what portfolio returns have to do with deviations. In the world of investments, risk is often defined as volatility, which is statistically calculated as the standard deviation of portfolio returns. So measuring the deviation in portfolio returns is really a measure of portfolio risk. For many investors, risk is a primary consideration for investing in a portfolio of stock. The higher the risk, the higher the expected return, and vice versa.
Calculate your portfolio return. Returns are how much you profited from the initial investment. That is, by what percentage did your initial investment increase? Subtract the ending value of your investment from the initial investment and then divide this number by your initial investment. For instance, if you invested $100 that went up to $150 in one year, then your return is ($150 - $100)/$100 = 50 percent.
Gather data. Let's assume you have a portfolio with the following returns for the past five years. Year 1 = 25 percent Year 2 = 5 percent Year 3 = 5 percent Year 4 = 10 percent Year 5 = 10 percent
Calculate the average of the returns for the past five years. This will be your point of reference for calculating deviation: 25+5+5+10+10 = 55. Compute the average by dividing by the total number of years: Fifty-five divided by 5 equals 11.
Square the difference of each year from the average and then take the sum. For instance, Year 1 = (25-11) ^2 = 196. Do this for each year and then find the sum of all years. Your answer should be 270.
Divide this number by the number of years minus 1: 270/4 = 67.5. Taking the square root of this number gives 8.21. The portfolio has an average return of 11 percent at an annual deviation of 8.21 percent.