What is beta? Learn it and grow your businessArticle added by Roccy DeFrancesco on November 29, 2012
Roccy Defrancesco

Roccy DeFrancesco

MI

Joined: May 24, 2006

Co-written by Drew Horter

Let’s start off with a simple question: Why learn about beta?

The answer is so you can better evaluate the investment options of your clients, and so you don’t have a competitor talking about beta to your clients without knowing what it is.

What is beta?

As it relates to investments and finance, the beta of an investment is a number describing the correlated volatility of an asset in relation to the volatility of the benchmark to which it's being compared.

Most use the S&P 500 stock index as the benchmark to measure risk of other investments against.

By definition, the benchmark itself has a beta of 1.0. Investments you compare to the benchmark are ranked according to how much they deviate (vary) from the benchmark.

Beta is calculated using regression analysis, and you can think of beta as the tendency of a security's returns to respond to swings in the market.

-A beta of 1 indicates that the security's price will move with the market.

-A beta of less than 1 means that the security will be less volatile than the market.

-A beta of greater than 1 indicates that the security will be more volatile than the market.

For example, if a stock's beta is 1.2, it's theoretically 20 percent more volatile than the market.

An asset has a beta of zero if its moves are not correlated with the benchmark's moves. Beta can also be a negative number, meaning that it generally moves opposite the benchmark.

Higher beta investments tend to be more volatile and, therefore, riskier, but provide the potential for higher returns. Lower beta investments pose less risk but generally offer lower returns.

Some investments challenge this idea by offering a lower beta with a track record of higher returns than the benchmark. I found one firm that specializes in low beta/high return mutual funds. For example, one mutual fund has a Beta of only 0.23 to the S&P 500, but has averaged 4.43 percent more than the S&P 500 for the last 10 years.

This money management platform fits in very well with advisors who use fixed indexed annuities to help their client build wealth for retirement.

The bottom line is that, if you are helping give advice to clients about their money, chances are a discussion about beta will help you educate clients and help them pick the right tools for protecting and growing their wealth.
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