Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Beta

What it is:

Beta is a measure of a stock's volatility relative to the overall market. It is most often calculated using a stock's movements relative to the S&P 500 Index over the trailing 12-month period.

How it works (Example):

A stock's beta is determined by analyzing how much its return fluctuates in relation to the overall market return. A stock with a beta of 1.0 will tend to move higher and lower in lockstep with the overall market. Stocks with a beta greater than 1.0 tend to be more volatile than the market, and those with betas below 1.0 tend to be less volatile than the underlying index. Stocks with betas of zero generally move independently of the broader market. And finally, stocks with negative betas tend to move in the opposite direction relative to the broader market. When the S&P tumbles, stocks with negative betas will move higher, and vice versa.

For example, a stock with a beta of 2.0 is usually twice as volatile as the broader market. If the S&P 500 were to fall by -10% next year, then the stock would be expected to fall about -20% (assuming that the stock behaves similar to how it has in the past). The stock would also be expected to gain more in an up market.

Beta is a measure of systematic risk.

Why it Matters:

The definition of beta on InvestingAnswersBeta can help investors choose investments that match their specific risk preferences. A risk-averse investor, for example, may want to avoid overweighting their portfolio with high-beta stocks to avoid excessive volatility. 

Individual stock betas are extremely important when putting together a portfolio of assets. A diversified portfolio consisting of assets with different betas lowers the overall risk of the portfolio.

Investors should note that beta is calculated using past price fluctuations and does not ensure that a security will behave the same going forward. Beta is used (most frequently in the Capital Asset Pricing Model, or CAPM) to forecast expected return of a stock or portfolio, not the actual return.  

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