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Alpha vs Beta: Measures of Investment Performance & Risk

Alpha vs Beta: Measures of Investment Performance & Risk

Alpha and beta are measures used by investors to evaluate the performance and risk of an investment security or portfolio.  Along with standard deviation, R-squared, and the Sharpe ratio, both are standard calculations that are used to evaluate an investment portfolio’s returns.

Alpha refers to how well an investment performed relative to a certain benchmark index. It tells you whether or not the investment outperformed (positive alpha) or underperformed (negative alpha) after adjusting for its risk, as measured by beta. A high alpha is always good.

Typically presented as a single number, an alpha of +1 means an investment’s return exceeded that of the benchmark by 1 percent, while an alpha of -2 means the investment underperformed by 2 percent. An alpha of 0 means an investment's return ma­tched that of the benchmark.

An investment's beta gives you information about an investment's volatility relative to the overall stock market. A beta of exactly 1 means that a stock, fund, or investment portfolio historically moves with the market, such as the S&P 500. In other words, if the S&P 500 falls by 5%, a stock with a beta of 1 can be expected to do the same.

A beta of more or less than 1 indicates that the stock should be more or less reactive than the overall market. For instance, if your portfolio's beta is 1.5, you can expect a 1.5% move for every 1% move in the market. A negative beta means that an investment moves in the opposite direction as the overall stock market.

The baseline measure for alpha is zero, meaning that an investment's performance does not exceed its relative benchmark. The baseline measure for beta is 1.0, meaning that an investment's price movement is the same as the benchmark index.

If you are more risk-averse, you might stay away from high-beta stocks. A more aggressive investor with a higher risk tolerance might be more inclined to invest in high-beta stocks.

Both alpha and beta are historical measures of past performance and aren’t guarantee of future results.


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