What Is Beta?
Of the handful of standard measures of investment risk, beta is one of the most widely used. Beta describes how volatile an individual investment is compared to the broader market. It’s, therefore, a very useful risk measure. Think of it as a tool that can help investors make decisions about mutual funds, stocks and other investments that are better aligned with their own appetite for risk.
Many investors already have an intuitive sense of beta in terms of the “riskiness” of different types of stock. For example, prices for utilities stocks have often tended to be more stable than the broader market. In contrast, small-cap stocks from the biotech or information technology sectors have often tended to be more volatile, experiencing proportionately larger swings in value than the broad market.
The concept of beta simply puts these kinds of observations on a firmer mathematical footing, quantifying (on a scale that starts at zero) how sensitive a particular investment has been to moves in the broader market.
A beta of one indicates that a particular stock has tended to move up and down, generally in lockstep, with the broader market. A beta closer to zero would indicate that a stock has often been less volatile than the market and not experienced such wide swings in value. Finally, a beta in excess of one would indicate that a stock’s value has been more volatile than the broad market.
According to standard financial theory, investments with higher expected returns tend to be more volatile. An investor who’s targeting higher returns or has a longer investment horizon may, therefore, be more willing to invest in higher beta investments. Conversely, an investor who is risk-averse may have less tolerance for volatility and instead favor low-beta investments.