I keep hearing this term "beta" applied to stocks. What does it mean?
Beta -- or if you want to get nitpicky about it, the coefficient of beta -- was a concept developed in the early 1960s by Nobel laureate William Sharpe. Simply put, it's a measure of risk that tells you how volatile an investment's returns are in relation to a specific market benchmark. In the case of stocks and stock funds, that benchmark is the Standard & Poor's 500 index.
Rather than bore you to tears with the details of how it's calculated, how's about I just give you a quick example of how it works. The S&P 500 is arbitrarily assigned a beta of 1.0. Stocks with betas greater than 1 are more volatile than the S&P 500, while those with lower betas fluctuate less. If the S&P 500 gains or loses 10 percent, you'd expect a stock with a beta of 1.2 to gain or lose 12 percent (1.2 times 10 percent). A stock with a beta of 0.8 would be expected to rise or fall 8 percent (0.8 times 10 percent).
While that all seems neat and tidy, there are a few caveats. First, beta works better for portfolios than for individual stocks. That's because beta is designed to measure the extent to which the overall market influences the movements of a stock. But other factors -- industry developments, new products, management snafus -- also affect a stock's price, and beta doesn't capture those.
Secondly, beta can sometimes be misleading. Notoriously volatile gold stocks, for example, often have low betas. Why? Because they tend to follow the ups and downs of inflation and commodity prices more than the overall stock market.
You can find betas for individual stocks at most online stock-quote engines, including Money.com's. For betas on funds, as well as other risk measures, get a Morningstar report on any fund at CNNfn.com.
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