What is Beta and Why It Matters
One of the investment terms that people use to describe stocks or mutual funds is beta. The beta is a term used to describe how volatile an investment is relative to a benchmark index, most commonly the S&P500.
A beta score of 1.0 means that the fund is equally volatile as the index. Similarly, a beta of 2.0 implies twice as much volatility, whereas a score of 0.5 can be interpreted as half as much volatility.
In today's choppy market environment, tracking the beta of your investments is vitally important. Financial advisers typically recommend low beta investments when it appears that a recession is ahead or a stock market decline may be looming. Examples of low beta sectors typically cited include consumer staples (toothpaste, laundry detergent, etc.) and utilities. Mutual fund categories that have low betas include growth & income, equity-income, and many large-cap value funds.
Likewise, high beta sectors are often recommended at market lows or when good times are anticipated. Examples of high beta sectors include technology, luxury goods, travel/tourism, etc. Mutual fund categories with high betas include : small cap, micro cap, or aggressive growth.
As a general rule, large companies are less volatile than small companies, and developed markets have lower betas than emerging markets. When measured against the S&P500, bond funds and commodities often have very small or negative betas.
If you're generally risk averse or have a relatively short time horizon, you may want to lighten up on beta to reduce the impact of market declines on your portfolio, especially as it appears the U.S. is heading towards a recession. If you have cash to invest and have a longer time horizon, the recent weaknesses in the global stock markets may soon present some excellent opportunities to buy.
If you need to find the beta of your investments, Yahoo! Finance is a great place to start.
The key to successful long-term investing is to be diversified in your investments (across asset classes, countries and market sectors) so that temporary market declines don't wipe you out. If you diversify correctly, you will end up with a mix of high beta and low beta investments.
The recent market events are proving the value of this strategy. Even though stocks are weak, high-quality bond investments have been rallying, as interest rates decline in anticipation of Federal Reserve rate cuts. Thus, even though stocks have declined, the bond portion of the portfolio has risen, so the effect on the entire portfolio is diminished. With regular rebalancing back to your intended targets, you will end up buying low and selling high.
Here's hoping that better market times are ahead and that you are able to stay in the market for another day. It sure looks as if it will be a bumpy ride.
A beta score of 1.0 means that the fund is equally volatile as the index. Similarly, a beta of 2.0 implies twice as much volatility, whereas a score of 0.5 can be interpreted as half as much volatility.
In today's choppy market environment, tracking the beta of your investments is vitally important. Financial advisers typically recommend low beta investments when it appears that a recession is ahead or a stock market decline may be looming. Examples of low beta sectors typically cited include consumer staples (toothpaste, laundry detergent, etc.) and utilities. Mutual fund categories that have low betas include growth & income, equity-income, and many large-cap value funds.
Likewise, high beta sectors are often recommended at market lows or when good times are anticipated. Examples of high beta sectors include technology, luxury goods, travel/tourism, etc. Mutual fund categories with high betas include : small cap, micro cap, or aggressive growth.
As a general rule, large companies are less volatile than small companies, and developed markets have lower betas than emerging markets. When measured against the S&P500, bond funds and commodities often have very small or negative betas.
If you're generally risk averse or have a relatively short time horizon, you may want to lighten up on beta to reduce the impact of market declines on your portfolio, especially as it appears the U.S. is heading towards a recession. If you have cash to invest and have a longer time horizon, the recent weaknesses in the global stock markets may soon present some excellent opportunities to buy.
If you need to find the beta of your investments, Yahoo! Finance is a great place to start.
The key to successful long-term investing is to be diversified in your investments (across asset classes, countries and market sectors) so that temporary market declines don't wipe you out. If you diversify correctly, you will end up with a mix of high beta and low beta investments.
The recent market events are proving the value of this strategy. Even though stocks are weak, high-quality bond investments have been rallying, as interest rates decline in anticipation of Federal Reserve rate cuts. Thus, even though stocks have declined, the bond portion of the portfolio has risen, so the effect on the entire portfolio is diminished. With regular rebalancing back to your intended targets, you will end up buying low and selling high.
Here's hoping that better market times are ahead and that you are able to stay in the market for another day. It sure looks as if it will be a bumpy ride.
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