What Is Beta, And Why Does It Matter?
Question: What is beta, and why should it matter to me?
Ramy S., Lebanon
Answer: There are two main goals in investing: making money. It's as simple as that., and not losing
How you feel about those two goals is probably determined by your age. Younger investors are willing to take risk, seeking nest egg, generating respectable income streams from a portfolio of mature, steady-as-she-goes stocks.that might eventually double or triple in value. Older investors just want to hang on to their
Yet even with these goals in mind, investors may unwittingly end up owning the wrong kinds of stocks. Perhaps the easiest way to know if you own the right stocks: Check the beta.
Beta is a measure of how fast arises and falls in relation to the broader market. For example, a with a beta of 3.0 rise (or fall) three times as fast as the . A with a beta of just 0.25 move up or down more slowly, even when the rest of the is making a bold move in either direction. A beta of 1.0 implies one-to-one parity with the .
Perhaps no sectors embody the notion of beta like the technology and utility sectors. An electric utility company such as New York-based Con Ed (NYSE: ED) is the proverbial tortoise in the race against the hares, with a beta of 0.18. Its dividend grows just 1% every but is as predictable as the sunrise. That is not necessarily a virtue to younger investors who seek capable of robust share price .
Younger investors may prefer tech, which are famous for surging (in the late 1990s) and crashing (a few years later). Perhaps the most popular high-beta of the past five years has been Apple (Nasdaq: AAPL), which rose more than 600% from early 2009 through the summer of 2012 but has since fallen roughly 40%. That's often too much action for conservative investors who are nearing retirement.
But wait: Why can't aging investors latch on to a fast-moving high-betalike Apple? They can and do. Indeed, it's wise to hold a few high-beta in an otherwise low-beta portfolio. They can add some growth to a portfolio that is otherwise mostly focused on income.
The key is to know the beta of your portfolio, and calculating it is quite simple. Let's presume you own five low-beta(which account for 90% of your portfolio), with the remainder of your portfolio in computer component maker Seagate Technology, which has a beta of 2.47.
Simply multiply each's beta by the percentage it is in your portfolio, and then add up the figures. Here's an example.
Even with the addition of a high-beta , this portfolio still has a total beta of only 0.42, which is quite low.
It may be helpful to first establish what kind of portfolio you want to have. Perhaps you would like it to be neither too risky nor too conservative, and therefore seek a portfolio of a beta of 1.0. If your current portfolio is above or below that figure, you can sell certainand replace them with others that help bring the beta toward the 1.0 mark.
One final thought: Investors tend to buy and sellwithout paying attention to the broader risk profile. By tracking the beta of your portfolio, you'll develop a very clear sense of whether you are too tilted toward growth or risk aversion.
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