how to calculate volatility of a portfolio in excel?

culbertauthor2023/11/28 11:31:58

The volatility of a portfolio is a key metric that helps investors evaluate the risk associated with their investment. Volatility measures the fluctuations in the value of a portfolio over a given period of time, and is expressed as the standard deviation of the portfolio's returns. In this article, we will learn how to calculate the volatility of a portfolio in Microsoft Excel, a popular spreadsheet software.

Step 1: Prepare the Data

First, gather the relevant data for your portfolio, such as the portfolio's components (e.g., stocks, bonds, or other assets), their weights, and the corresponding historical returns for each asset. You can obtain this data from financial websites, such as Yahoo Finance or Google Finance, or from your own research.

Step 2: Calculate the Portfolio Returns

For each period (e.g., monthly or yearly), calculate the portfolio's total return by adding the returns of each asset together and dividing by the number of assets. For example, if you have three assets A, B, and C, and their respective returns for a given period are 5% (A), 3% (B), and 7% (C), then the portfolio return for that period would be (5 + 3 + 7)/3 = 5%.

Step 3: Calculate the Portfolio Volatility

To calculate the volatility, you need to find the sample standard deviation of the portfolio returns. The sample standard deviation is a measure of how closely the returns of a portfolio follow its expected value, and it is calculated by finding the square root of the variance of the returns. The variance is the average of the squared differences between the actual returns and the expected returns.

In Excel, you can use the STDEV.P function to calculate the sample standard deviation. For example, if the expected returns for assets A, B, and C were 5%, 3%, and 7%, respectively, then the variance would be (5-5)^2 + (3-5)^2 + (7-5)^2 = 4 + 2 + 4 = 10, and the sample standard deviation would be sqrt(10) ≈ 3.16.

Step 4: Calculate the Portfolio Volatility

To calculate the portfolio volatility, use the sample standard deviation found in the previous step and multiply it by the portfolio's standard deviation factor, which is usually 2.588. The portfolio volatility is then equal to the sample standard deviation multiplied by the standard deviation factor.

For example, if the sample standard deviation of the portfolio returns was 3.16, then the volatility would be 3.16 * 2.588 ≈ 8.0%.

Calculating the volatility of a portfolio in Excel is a simple yet effective way to evaluate the risk associated with your investment. By understanding the volatility of your portfolio, you can make more informed decisions about your investments and better balance risk and return. Remember to update the data regularly to keep the most accurate volatility calculations.