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Yoshiyoshi Hirokawa/Getty Images November 10, 2022 Bankrate reporter Brian Baker covers investing and retirement. He has previous experience as an industry analyst at an investment firm. Baker is passionate about helping people make sense of complicated financial topics so that they can plan for their financial futures. Brian Beers is the managing editor for the Wealth team at Bankrate. He oversees editorial coverage of banking, investing, the economy and all things money. Bankrate logo The Bankrate promise
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You have money questions. Bankrate has answers. Our experts have been helping you master your money for over four decades. We continually strive to provide consumers with the expert advice and tools needed to succeed throughout life’s financial journey. Bankrate follows a strict , so you can trust that our content is honest and accurate. Our award-winning editors and reporters create honest and accurate content to help you make the right financial decisions. The content created by our editorial staff is objective, factual, and not influenced by our advertisers. We’re transparent about how we are able to bring quality content, competitive rates, and useful tools to you by explaining how we make money. Bankrate.com is an independent, advertising-supported publisher and comparison service. We are compensated in exchange for placement of sponsored products and, services, or by you clicking on certain links posted on our site. Therefore, this compensation may impact how, where and in what order products appear within listing categories. Other factors, such as our own proprietary website rules and whether a product is offered in your area or at your self-selected credit score range can also impact how and where products appear on this site. While we strive to provide a wide range offers, Bankrate does not include information about every financial or credit product or service. Alpha and beta are two terms that get thrown around a lot in investing. They sound complicated, but they’re actually much simpler than they seem. Here’s what you need to know about alpha and beta in investing and the difference between the two terms. What is alpha in investing
measures the return on an investment above what would be expected based on its level of risk. It’s also sometimes used as a simple measure of whether an asset outperformed an appropriate benchmark such as whether an mutual fund outperformed an index such as the . How to calculate alpha
Alpha is sometimes casually referred to as a measure of outperformance, meaning the alpha is the difference between what an asset returned and what its benchmark returned. For example, if a stock fund returned 12 percent and the S&P 500 returned 10 percent, the alpha would be 2 percent. But alpha should really be used to measure return in excess of what would be expected for a given level of risk. If the fund manager outperformed an index, it may have been because the fund assumed more risk than that of the index. Beta, which measures an asset’s volatility and can be used to gauge risk, can be used in determining expected return. If a stock has a beta of 1.2, it might be considered 20 percent riskier than the benchmark and therefore should compensate investors with a higher expected return. If the index returned 10 percent, the stock should return 12 percent. If instead, the stock returned 14 percent, the additional 2 percent would be considered alpha. Examples of alpha
Alpha is most often used in the fund industry to measure a portfolio manager’s skill. Generating alpha is the goal of active fund managers because they’re earning returns above what would be expected for a given level of risk-taking. A fund manager may generate alpha over any time horizon, but it’s most valuable when it’s generated consistently over long periods. ’s company (BRK.B) has outperformed the S&P 500 by nearly 10 percent annually since 1965. This means that a $1,000 investment in the S&P 500 at the beginning of 1965 would have been worth about $296,000 at the end of 2021, whereas the same investment in Berkshire would have been worth more than $34 million. That’s a lot of alpha. What is beta in investing
, or the beta coefficient, measures volatility relative to the market and can be used as a risk measure. The market always has a beta of 1, so betas above 1 are considered more volatile than the market, while betas below 1 are considered less volatile. How to calculate beta
Beta is calculated by taking the covariance between the return of an asset and the return of the market and dividing it by the variance of the market. The measure is backward looking because you’re using historical data in the calculation of beta. Beta may or may not be a useful measure on a go-forward basis. Fortunately, you won’t have to calculate the beta for each stock you’re looking at. The beta for any stock can be found on most popular financial websites or through your online broker. Examples of beta
Here are three popular securities and their betas as of Nov. 4, 2022. Vanguard 500 Index Fund (VOO) – 1.00 (TSLA) – 2.13 (WMT) – 0.51 Different investors might be interested in each of those investments for different reasons. A passive investor looking to earn the market return might choose the Vanguard , while a more aggressive investor who is comfortable with higher levels of risk might select Tesla. Conservative investors looking for stability might select Walmart because of its low expected volatility. Differences between alpha and beta
Though both greek letters, alpha and beta are quite different from each other. Alpha is a way to measure excess return, while beta is used to measure the volatility, or risk, of an asset. Beta might also be referred to as the return you can earn by passively owning the market. You can’t earn alpha by investing in a benchmark index fund. Bottom line
While alpha and beta might sound like complex and intimidating financial terms, they’re really just ways to measure risk and return. While both measures might be considered before making an investment, it is important to remember that they’re backward-looking. Historical alpha isn’t a guarantee of future results and an asset’s volatility can fluctuate from one day to the next. SHARE: Bankrate reporter Brian Baker covers investing and retirement. He has previous experience as an industry analyst at an investment firm. Baker is passionate about helping people make sense of complicated financial topics so that they can plan for their financial futures. Brian Beers is the managing editor for the Wealth team at Bankrate. He oversees editorial coverage of banking, investing, the economy and all things money. Related Articles