FINANCIAL TOOL
Beta
How volatile is your stock or fund likely to be?
More importantly, how likely is it to move more or less than the overall market?
That’s where beta helps you determine whether a stock or fund meets your need or desire for risk.
Here’s the technical definition. Don’t worry, you don’t need to memorize this to use its answer!
Beta =
Covariance of stock returns vs benchmark returns
Variance of benchmark returns
The beta can range from -1 to 1.
A beta of 1 means it has historically moved $1 for every $1 move in the benchmark (like the S&P 500).
A beta of -1 means it has historically moved exactly opposite to the market: negative $1 for every positive $1 move in the benchmark.
So imagine you want to invest but don’t want the full risk of the market. Maybe you’re comfortable with 80% of typical market movement, but not 100%.
Then one factor you can look for in a group of stocks or a fund is a beta equal to 0.8. This indicates that it has historically moved about $0.80 for every $1 move in the market.
Remember that this number uses past pricing data. It is not a prediction of future price movement. But without knowing the future, it’s a good indicator among many that you can use when selecting how much market risk to take on.