Question

Suppose you wish to invest money safely and are trying to decide between stock options in two companies. The average rates of return are the same for both companies but, one company has a much larger standard deviation of its rates of return. a. Which company should you invest in? The company with the smaller standard deviation The company with the larger standard deviation b. Why is this the better choice?

Answer 1

If the average rates of return are the same for both companies, but one company has a much larger standard deviation of its rates of return. You should invest in a company with a smaller standard deviation.

This is the better choice because a larger standard deviation means that the company's returns are more variable, which implies more risk. While higher risk can result in higher returns, it can also result in significant losses. Investing in a company with a smaller standard deviation of its rates of return will likely result in a more stable return on investment and therefore be a safer investment.

In general, investors should consider both the average and variability returns when making investment decisions. While higher average returns are desirable, they may not be worth the additional risk if the variability of returns is too high.