THE BEECHMONT CREST ONLINE GUIDE TO STOCKS AND INVESTING
BETA
Every investment entails some risk. Even a government bond, the very symbol of security, could become worthless in the unlikely event of a collapse of our national government. But while this scenario is technically possible, it isn’t something that is going to make the average investor lose too much sleep.
On the other hand, an investment in a high-tech start-up might entail a lot of risk. (Remember all the investors who got clobbered when the high-tech bubble burst in the early 00s?) But this is only one side of the story: many people who invested in high-tech stocks in 1998 or 1999 became millionaires overnight.
The beta is an investment’s relative degree of risk. Beta is therefore measured against the overall volatility of the market.
The market’s beta is always 1.0. If your investment has a beta of 1.0, then you can expect it to follow the market up or down.
If an investment has a beta of 1.2, then it is 20% more volatile than the market. So it the market is up 10%, then the investment will be up (on average) about 20% more, or 12%.
Now suppose that an investment has a beta of .50. The variation in returns on this investment are only about half of the variation in returns in the overall market. So if the market goes up by 10%, this investment will be up 5%, on average.
The above examples discuss the impact of beta when the market is going up. The reserve side of the coin is that beta also impacts stocks when the market goes down. A volatile stock with a beta of 1.5 will loose 15% of its value when the overall market declines by 10%.