Beta is a measure of the volatility or risk associated with an investment such as a fund, portfolio or security; with market movements. Beta measures how poorly an investment will perform during a bear market, and how high the returns will be during a bull market.
Beta is calculated using regression analysis. By definition, the market (which for the purpose of calculation is generally considered to be the S&P 500) has a beta of 1.0, and individual stocks are ranked on the basis of how much they deviate from the market. It must be noted that for funds that don't correlate well to the S&P, beta will not hold a lot of meaning. So the simple rule is:
Beta < 1 typically means the security is stable and is not affected by the swings in the stock market. A good example of this is a treasury bill which has a low beta, as its price does not go up or down significantly. A beta < 1 could also mean a highly volatile investment with no correlation to market movements.
Beta = 1 implies that the security's price will move with the market.
Beta > 1 indicates that the security is volatile and is significantly impacted by market movements. For Ex: if a stock has a beta of 1.10, the stock will outperform the market by 10% during a bull market and vice versa.
Beta for the long term investor
If an investor is planning to buy or sell a security within a short period of time where price volatility becomes important, beta may prove to be useful. However for a long term value investor, beta as a single measure of risk may prove to be an inaccurate indicator. Fundamental analysis will prove to be much more useful and will give a clearer picture of long-term risks.
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