Investing is basically making decisions based upon data and evidence with the aim of obtaining a return on investment while also managing risk of loss. The key to success in this endeavor is the ability to determine how much potential reward an asset could bring as well as how much risk investing in the particular asset may include. This can be done by looking at historical financial data of the particular asset as well as key economic indicators.
It is essential that you are constantly analyzing your investment portfolio while also analyzing potential investment opportunities that you may want to consider adding to your portfolio in the future. In this way you will be able to maintain a balance between risk and reward that is suitable for your financial objectives and circumstances. There are several different methods for analyzing financial investments. One way is to look at two key measurements: alpha and beta.
Basic differences between alpha and beta
Alpha and beta are two different ways to measure the performance of financial investments. This could include a single stock, an entire portfolio or even the performance of an investment fund. As an investor, understanding the differences between these two views of investment assets can help you make better decisions on how to invest your capital.
Alpha is a metric that expresses how much an investment has returned in contrast to the rest of the market. Usually, this comparison is made against some type of market index or a benchmark for the broader financial market.
In contrast, the beta metric measures an investment’s volatility compared to the broader market, using market indices and benchmarks.
The numerical metric used to express the alpha of an investment is an expression of the percentage of how a specific investment has overperformed or underperformed a particular broader market index or benchmark. Alpha is actually expressed as a single digit, such as -1 or 4, which would indicate an investment performing 1% lower than the broader market or 4% above a specific index.
Beta for a stock or other type of investment is expressed through a measurement that is referred to as the beta coefficient. A beta coefficient of 1 indicates that the asset moves in line with the market index being utilized for comparison. If an asset has a beta coefficient of less than 1 it means that the asset has less volatility. On the other hand, a beta coefficient of more than 1 indicates volatility that is higher than the broader market.
For example, a stock with a beta coefficient of 1.25 indicates that the stock volatility is 25% higher than the market index.
Balancing alpha and beta in your portfolio
How much alpha and beta should be a part of your investment portfolio can vary from person to person. It all comes down to how much risk you are willing to take in return for more potential larger gains. Make sure to do a comprehensive analysis of your current financial situation with a professional financial advisor to chart out a path for optimizing your wealth management endeavors.
Any opinions are those of the author and not necessarily those of Raymond James. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. All opinions are as of this date and are subject to change without notice. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. Past performance is not a guarantee of future results.