As a new investor, you may find yourself feeling much like you did your freshman year at college:
- You hear lots of confusing Greek words.
- You suspect that most people also don’t have any idea what they’re doing.
- You hope that in the end, you’ll end up being able to make some money.
A thorough understanding of the intricacies of investing only help propel you toward success and part of that foundation involves determining a particular stock’s risk.
What is beta in investing?
Beta is a stock’s volatility relative to the market. In layman’s terms, it means that a particular stock is either riskier or less risky than the market average. The market has a beta of 1. Stocks which move more than the market over time have a beta above 1. Stocks with less movement than the market have a beta below 1. A stock with a beta of 1.3 would be 30% more volatile than the market.
Index funds allow your investment to track right along the market that you invested in, which gives them a beta of 1. On the flip side, individual stocks track either above or below the market, making them usually more risky, but possibly more lucrative.
Who measures beta?
Analysts measure beta for a stock relative to a market, an individual stock index like the Dow, Nasdaq or S&P 500. The beta can vary based on who gives the rating and their assessment of that stock’s volatility.
Beta is based on historical stock pricing. If a stock recently becomes more volatile but has a long history of conservatism, the average beta rating may show it to be less risky than it actually is at the present moment.
In addition to checking a stock’s beta, you should follow recent press coverage and filings of your interested company so that you’re aware of current activities that may contribute to increased volatility for that stock.
High risk, higher reward?
Purchasing riskier investments can lead to greater rewards but potentially greater losses. Stocks with low beta, like utility stocks, usually are a fairly conservative investment.
Stocks with a higher beta, like biotech stocks, are more volatile and risky. Your individual tolerance for risk should be your driving factor when choosing investments and the beta provides an easy-to-identify numerical system for assigning volatility.
How do I use beta?
If you’re looking to invest in single stocks, look for companies which have beta ratings that mirror your investing strategy and comfort level. Most investors who rely on beta ratings for their stock selection are passive investors who aren’t interested in outperforming the market. When reviewing the beta of a stock, check which market the stock is compared to, since it could be the S&P or the more-conservative U.S. Treasuries.
Knowing the beta of a stock you’re interested in can give you indicators of its volatility and risk and whether it may fit into your overall investment strategy. Beta only snapshots historical data and doesn’t include recent events, so pay attention to recent news and press releases concerning the company.