In an endeavor to guide common investors in evaluating potential risks associated with mutual funds, stocks and bonds, financial experts have introduced some indicators.

These statistical measures are alpha, beta, standard deviation and r-squared. These indicators strive to predict risks and volatility associated with a security or fund by analyzing past performances after comparing with a benchmark index. They are major elements of Modern Portfolio Theory. Here is brief explanation of these commonly used indicators.

The excess return of a mutual fund or stock relative to the return delivered by a benchmark index, for a certain period, is its “alpha”. It compares past performance of a fund on risk-adjusted basis relative to the index.

A positive alpha of 1.0 indicates that the fund has outperformed benchmark index by 1% while a negative alpha indicate underperformance. For an investor, funds with positive alpha are an obvious choice.

“Beta” measures the volatility of a fund in comparison to the market.Simply stated, it represents behavior of a fund in response to market swings. As per definition, market has a Beta of 1.0.

A fund having beta 1.0 is expected to move with the market. Beta less than one, mean that the fund is less volatile than market. Funds having beta more than 1.0 are volatile than market. If you are a conservative investor then look for a fund with low beta.

Standard deviation measures the deviation of performance of a fund from its historical average. Performance, in financial terms is referred to the annual rate of return. A volatile fund or stock has high standard deviation. For a mutual fund this tool gives an idea about how the fund performed in comparison with expected return.

R-squared represent the percentage of portfolio movement that can be explained by movements of a benchmark index. For mutual funds constituted mainly by bonds, benchmark is U.S. Treasury Bill. For equity oriented mutual fund benchmark is usually S&P500 Index.

Value of R-squared may range from 0-100. Avoid funds with high value of R-square as it almost replicated index performance. It is better to go for an index fund than paying for such fund.