I like Vanguard's risk scale. I don't honestly think you can make finer distinctions than that. But you need to be alert for the fact that they're categories, not linear! Total Stock with "risk potential 4" is much
more than "twice as risky" as Total Bond with "risk potential 2."
I'm pretty sure that Vanguard uses some simple qualitative rules for assigning those categories, though I haven't reverse-engineered how they decide between 4 and 5. I'm guessing that if Vanguard tried to categorize Magellan on their scale, being a broadly diversified 100%-stock fund, they would put it into category 4, same as Total Stock. I think this because many of Vanguard's actively-managed broad 100%-stock funds, like WIndsor, Diversified Equity, and Morgan Growth go into category 4, and also because Magellan has (alas!) behaved a lot like the S&P 500 and/or Total Stock, which are in category 4.
I also like this exercise. Find a growth chart, as long as you can find, and preferable a dynamic one where you can slide the mouse along and watch the totals go up and down. You can do this for Vanguard's funds at its own website, e.g. the Price & Performance tab for STAR, here
, and then add Total Stock for comparison. I slide the mouse along, I watch the numbers, and I commune with myself and ask myself very seriously--"how would I really
feel about seeing $19,500 in my account one day...
...and then seeing $17,270, two thousand dollars less, just a couple of months later? This is risk as actually experienced by the investor.
Vanguard lets you add up to two other funds for comparison, and if you add Total Stock I think you'll see that Total Stock obviously fluctuates more than STAR. And you can go to Morningstar.com and get growth charts for more than one company, that go more than ten years back.
My personal favorite "measure of risk" is very simple. By what percentage did the fund fall between 12/31/2007 and 2/28/2009? If we look at Magellan, Total Stock, and STAR, and use Morningstar's feature that lets us set the $10,000 starting point at any date we like, I see this:
(Morningstar's growth charts are free, you do not need a paid subscription, and instructions for using them are on the Bogleheads' Wiki here
Most broad stock funds dropped "about 50%." We see that Total Stock dropped 48%. Magellan dropped 57%, shame on Magellan, boo, hiss! And, again, it is clear that STAR, which only dropped 34%, was less risky than the others. The reason, of course, is that STAR is a balanced fund that contains both stocks and bonds, and is expected to have both less risk AND less return.
And then there's standard deviation. Standard deviation is a mathematical measure of fluctuation or volatility, and it's most intuitively
meaningful when it is measuring things that are statistically "better behaved" than financial data. But you can do math with it, and it's useful in two ways. First, it goes into calculating the Sharpe ratio
, which is a measure of risk-adjusted return. It is very easy to think that one fund is better than another because it has had higher returns, but it isn't really if it also had higher volatility, and standard deviation can be used to measure that. The second thing is that it is one of several numbers that are input data in calculating "efficient frontiers" and applying modern portfolio theory (MPT) and generally following a strategy which some Bogleheads call "slice and dice." Under the right circumstances, MPT says that the whole can do a little bit better than the sum of its parts, and that by blending uncorrelated assets you can sometimes improve return in relation to risk, and standard deviation is one of the numbers that goes into that strategy.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.