Coefficient of Variation

The scattered data points surrounding the mean refer to the coefficient of variation. The measure represents the data dispersion across multiple series of data. The coefficient of variation is comparatively better and a more reliable option than the traditional deviation, which focuses on the mean of the data only. The former offers a plethora of effective tools that work wonders when it comes to comparing data points between multiple data series.

What does Coefficient of Variation Mean?

In the investment and financial context, this statistical measure plays a pivotal role in investment decisions. It tells you the risk-to-reward ratio, a concept that gives you the details of the risks involved in the investment and the rewards it may generate. The Volatility level represents the risks, while the mean signifies the returns. The concept is commonly used by investors trading different types of securities and commodities in the financial Market. They consider the volatility and mean ratio to identify the risk the investment carries and the returns it is likely to generate.

Most investors invest in the securities that come with the minimal risk to reward ratio, as the lower the ratio, the lesser the risk involved in the transaction. They make the investment decision based on the risk associated with the transaction. The higher the coefficient of variation of a security, the more volatile the transaction is, and the lesser the returns are expected. This measure does not work if the expected Return on Investment falls below zero. From the financial context, the mathematical formula of the coefficient of variation is:

Volatility / expected returns on investment x 100%

So, what is a good coefficient of variation percentage? Ideally, an investor who is more concerned about the volatility level of the investment than the returns will want to invest in the securities that have the lowest coefficient of variation ratio. Those who want high returns and are willing to bear risks look for investment opportunities with a high coefficient of variation. The higher the ratio, the more risk the investment carries, and the better return it generates.

Coefficient of Variation Formula

Here’s how to calculate the coefficient of variation:

Coefficient of Variation = (Standard Deviation / Mean) * 100

The returns expected from the investment must not be zero. The formula may not work or mislead the investor if the denominator is zero. series.

Coefficient of Variation Example

Suppose, Raj is looking for an investment with steady Income and minimal risk. Simply put, he wants to invest in securities that can generate stable profits and diversify the investment Portfolio. Raj invested is confused between stocks, Bonds, and ETFs.

So, in such situation, the best way to decide the right investment is by calculating the coefficient of variation of the securities.

Raj has to compare the volatility rate of the investment, expected returns, and then multiply it by 100%. The investment with the lowest coefficient of variation is considered an ideal choice for your friend, as they are looking for a safe and stable source of income.