What Beta Means for Investors

If the beta is below 1, the stock either has lower volatility than the market, or it’s a volatile asset whose price movements are not highly correlated with the overall market. The price of Treasury bills (T-bills) has a beta lower than 1 because lastminute com cloud devops engineer full remote working smartrecruiters T-bills don’t move in relation to the overall market. A stock’s beta will change over time as it relates a stock’s performance to the returns of the overall market. While a stock that deviates very little from the market doesn’t add a lot of risk to a portfolio, it also doesn’t increase the potential for greater returns. The arbitrage pricing theory (APT) has multiple factors in its model and thus requires multiple betas.

Instead, beta can be used with other metrics like alpha, which tells an investor whether the actual returns on investment exceeded what its beta projected. The investor also wants to calculate the beta of Coca-Cola in comparison to the S&P 500. The recent six-year data shows that Coca-Cola and S&P 500 have a covariance of 14.15, and the variance of Coca-Cola is 26.59. Let us take, for example, an investor who wants to calculate the beta of Nike compared to the S&P 500.

Investors who are willing to take on more risk may want to invest in stocks with higher betas. These have some similarity to bonds, in that they tend to pay consistent dividends, and their prospects are not strongly dependent on economic cycles. They are still stocks, so the market price will be affected by overall stock market trends, even if this does not make sense. That is, if a portfolio consists of 80% asset A and 20% asset B, then the beta of the portfolio is 80% times the beta of asset A and 20% times the beta of asset B. Typically, volatility is a sign of risk, with higher betas suggesting greater risk and lower betas projecting lower risk. Thus, stocks with more significant betas may gain more during bull markets.

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In the case of levered beta, the beta increases as a company’s total debt level rises. A beta value of more than 1.0 implies that the stock will be more volatile than the market, while a beta value of less than 1.0 predicts lower volatility. In a bull market, a beta above 1.0 will likely produce better returns but also come with more risk. Beta can be used to help diversify a portfolio and make better investment decisions.

Investors who beta to evaluate a stock also evaluate it from other perspectives—such as fundamental or technical factors—before assuming it will add or remove risk from a portfolio. For beta to provide useful insight, the market used as a benchmark should be related to the stock. For example, a bond ETF’s beta with the S&P 500 as the benchmark would not be helpful to an investor because bonds and stocks are too dissimilar. Others are willing to take on additional risk how to generate bitcoins for free for the chance of increased rewards. Every investor needs to have a good understanding of their own risk tolerance, and a knowledge of which investments match their risk preferences.

The Capital Asset Pricing Model (CAPM)

As an example, consider an electric utility company with a β of 0.45, which would have returned only 45% of what the market returned in a given period. Many brokerage firms calculate the betas of securities they trade and then publish their calculations in a beta book. These books offer estimates of the beta for almost any publicly-traded company. Attempts have been made to estimate the three ingredient components separately, but this has not led to better estimates of market-betas.

Quickonomics provides free access to education on economic topics to everyone around the world. Our mission is to empower people to make better decisions for their personal success and the benefit of society. Most fixed income instruments and commodities tend to have low or zero betas; call options tend to have high betas; and put options and short positions and some inverse ETFs tend to have negative betas.

1. It compares the volatility (risk) of a levered company to the risk of the market.
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3. Meanwhile, alpha compares a particular stock’s actual performance to the market’s performance.
4. It aids investors in constructing a diversified portfolio aligned with their risk tolerance and investment goals.
5. Our mission is to empower people to make better decisions for their personal success and the benefit of society.

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However, beta is calculated using historical data points and is less meaningful for investors looking to how to buy gemini dollar predict a stock’s future movements for long-term investments. A stock’s volatility can change significantly over time, depending on a company’s growth stage and other factors. The beta coefficient is crucial for investors and portfolio managers as it provides an estimate of an investment’s risk profile relative to the market. High-beta investments are suitable for risk-tolerant investors aiming for higher returns, understanding that such investments come with increased volatility. Conversely, low-beta investments might appeal to conservative investors looking for more stable, albeit potentially lower, returns. The beta coefficient also plays a vital role in the Capital Asset Pricing Model (CAPM) to calculate the expected return of an asset, considering its risk relative to the market.

Beta coefficient is an important input in the capital asset pricing model (CAPM). CAPM estimates a stock’s required rate of return i.e. (cost of equity) as the sum of the risk free interest rate and the stock’s equity risk premium. A stock’s equity risk premium is the product of the stock’s beta coefficient and the market risk premium, the difference between the broad market return and the risk free interest rate. In finance, the beta (β or market beta or beta coefficient) is a statistic that measures the expected increase or decrease of an individual stock price in proportion to movements of the stock market as a whole.