Beta measures a stock’s volatility compared to the overall market. A beta above 1 means the stock is more volatile, while a beta below 1 means it is less volatile. Calculating beta involves comparing the stock’s past price movements to market indices. A financial advisor can use beta to help match your investments to your risk tolerance and goals.
What Is the Beta of a Stock?
Investors use beta to better understand the risk associated with a particular investment compared to the broader market. Beta helps with this by measuring a stock’s volatility relative to a benchmark index, typically the S&P 500.
A beta of 1 indicates that the stock’s price tends to move in tandem with the market. A beta greater than 1 suggests that the stock is more volatile than the market. A beta less than 1 indicates less volatility. The difference helps investors gauge how much risk they are taking on and can be a valuable tool in portfolio management.
Beta can indicate how a stock might react to market changes. For example, a stock with a high beta might experience significant price swings during market turbulence, offering potential for higher returns but also greater risk. Conversely, a low-beta stock might provide more stability, making it attractive to risk-averse investors.
Understanding a stock’s beta can help investors align their portfolios with their risk tolerance and investment goals, whether they are seeking aggressive growth or steady income. Beta values for individual stocks may be included in listings from market information services but it can also be useful to know how to calculate beta.
How to Calculate Beta
To calculate the beta of a stock, you need historical price data for both the stock and the market index. This data is typically available throughfinancial newswebsites, stock market apps, or brokerage platforms.
The time frame for this data can vary, but a common period is five years of monthly returns. This period provides a balance between capturing enough data points for accuracy and reflecting recent market conditions.
Once you have the historical price data, the next step is to calculate the returns for both the stock and the market index. Returns are calculated by taking the percentage change in price from one period to the next. For example, if a stock’s price increased from $100 to $105 over a month, the return for that month would be 5%. Repeat this calculation for each period in your data set to create a series of returns for both the stock and the market index.
With the returns calculated, you can now perform a regression analysis to determine the beta. This statistical method assesses the relationship between the stock’s returns and the market’s returns.
Most spreadsheet software has built-in functions to perform regression analysis. When using one of these functions, the slope of the regression line represents the beta.
What Are the Beta Values?
Beta values typically range from 0 to 3. A beta of 1 suggests that the stock’s price will likely move in the same direction and distance as the market. If a stock has a beta greater than 1, it is considered more volatile than the market.
Conversely, a beta of less than 1 indicates that the stock is less volatile. This remains true as long as beta remains positive, or between 0 and 1. As an example, a beta of -2 is less than zero, but would be more volatile than the market.
Beta helps to suggest likely returns. So a stock with a beta of 1 is expected to post the same return as the market over a given period. One with a beta of 1.5 typically generates 150% of the market return. A company whose shares have a beta of 0.5 is expected to return 50% of the market return during a set time frame. A company with a negative beta of -0.5 has historically tended to move in the opposite direction of the market. That is, if the market is up 10% these shares would lose 5%.
Interpreting beta values depends on the stock and the investor's goals and risk tolerance. Risk-averse investors may prefer stocks with lower beta values, as they are less affected by market swings. Investors looking for higher returns might choose higher beta stocks, knowing they come with greater risk.
How an Investor Can Use the Beta of a Stock
In portfolio management, beta values play a role in diversification strategies. By combining stocks with varying beta values, investors can create a balanced portfolio that aligns with their risk tolerance and investment objectives. For example, a portfolio with a mix of high and low-beta stocks can potentially offer both growth opportunities and stability.
This strategy allows investors to benefit from the growth potential of riskier stocks while cushioning against potential losses with more stable investments. Understanding how to use beta effectively can thus enhance an investor’s ability to diversify and manage their portfolio efficiently.
Beta has limitations as well, including the fact that it relies on historical data that may not reflect future performance. Beta may also vary during specific time periods as well as by industry. For example, high-tech startups generally have higher betas than established public utilities.
Bottom Line
Investors can calculate the beta of a stock to assess the risk associated with a particular investment relative to the market. Beta is a measure of a stock’s volatility in comparison to the overall market, typically represented by a benchmark index like the S&P 500. A beta greater than 1 indicates that the stock is more volatile than the market, while a beta less than 1 suggests it is less volatile.
Tips for Investment Planning
- A financial advisor can help you mitigate risk for your portfolio. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset's asset allocation calculator can help you determine how to apportion your investment portfolio among the various asset classes.
- If you want to diversify your portfolio, here's a roundup of 13 investments to consider.
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