- The Difference Between Beta & Implied Volatility
- Is the Total Stock Market More Stable Than the S&P 500?
- Do You Make More by Investing in Low Price Stocks Rather Than High Price?
- Why Would Beta Be Important in Recommending Mutual Funds?
- Can a Bank Stock Have a Beta Over Two?
- What Does Beta Measure in the Stock Market?
When researching stocks for investment, take a glance at the "beta" number. This value measures the volatility of a stock compared with the volatility of the market as a whole. A high beta means the stock price is more sensitive to news and information, and will move faster than a stock with low beta. In general, high beta means high risk, but also offers the possibility of high returns if the stock turns out to be a good investment.
The beta value of the entire stock market, as measured by indexes such as the Standard & Poor's 500, is 1. A stock with a beta value of 1 is just as risky as the stock market as a whole, and its price change tracks that of the index. Investors with low tolerance for volatility would seek a stock with a beta value of 1 or lower. Perception plays an important role in this equation; in general, bigger companies with more predictable earnings and dividends will carry a lower beta value. Bank and insurance stocks, utilities and large conglomerates all tend to have lower beta. However, report published by ABG Analytics found that in January 2013, banking giant Citigroup stock carried a beta of 2, meaning the stock was exactly twice as volatile and risky as the market.
An investment with zero beta means no volatility and no risk. This would leave out stocks. Instead, money market funds with a constant share value of $1, certificates of deposit backed by federal deposit insurance, and cash in savings and checking accounts all should have zero beta. The cash in your wallet also has zero beta: The value of a dollar bill will always be $1, and carries no risk of a fluctuation in value. Of course, inflation erodes the purchasing power of money, meaning your zero-beta investment actually loses if it pays interest at less than the rate of inflation.
A negative beta correlation would mean an investment that moves in the opposite direction from the stock market. When the market rises, then a negative-beta investment generally falls. When the market falls, then the negative-beta investment will tend to rise. This is generally true of gold stocks and gold bullion. Because gold is seen as a more secure store of value than currency, a market crash prompts investors to sell their stocks and either move into cash (for zero beta) or buy gold (for negative beta).
Risk Factors and Beta
A negative beta coefficient does not necessarily mean absence of risk. Instead, negative beta means your investment offers a hedge against serious market downturns. If the market continues rising, however, a negative-beta investment is losing money through opportunity risk -- the loss of the chance to make higher returns -- and inflation risk, in which a low rate of return does not keep pace with inflation. Because the stock market has historically produced a positive return in most years, simply investing in negative- or low-beta stocks increases these risks over time.
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