The Difference Between Alpha and Beta

Anyone who follows the financial news has probably heard the terms “alpha” and “beta” in relation to investing. However, it’s rarely explained how important they are when it comes to making investment decisions.

Alpha is a risk-adjusted measure of an investment’s performance. It takes the volatility of an individual investment and compares its risk-adjusted performance to a benchmark index.

The S&P 500, for instance, is a common benchmark for U.S. stock funds. The excess return (or loss) of the investment relative to that of the benchmark index is its alpha.

Alpha is a risk-adjusted measure of an investment’s performance.

  • A positive alpha means a fund has performed better than its benchmark.
  • A negative alpha means the fund has underperformed its benchmark.

In short, the higher the alpha, the better.

Beta measures the volatility (risk) of an investment or a portfolio compared to the market as a whole. Think of it as the tendency of an investment’s return to respond to swings in the market.

An investment with a beta of 1.0 would move exactly in step with the market. An investment or portfolio with a beta of less than 1.0 means it would be less volatile than the market, and one with a beta greater than 1.0 would be more volatile.

Beta measures the volatility (risk) of an investment or a portfolio compared to the market as a whole.

A beta of 1.15, for instance, means the investment or portfolio’s beta is likely 15% more volatile than the market.

Essentially, if you’re looking for a lower-risk fund or portfolio, look for one with a low beta. If you’re willing to take on more risk in exchange for the potential of higher return, look for a higher beta.

In some of my future posts I’ll break down other industry terms and jargon.

Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.

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  • Jim Sturgeon

    Helpful! Very easy to understand. Thx…. Looking forward to other industry terms & jargons.

    • http://musserstephen.wordpress.com Steve Musser, Global Marketing Manager, Principal Funds

      Thanks Jim. Keep checking out the blog – if you haven’t already subscribed to email notification, please do – our goal is to educate and inform.

  • Joel Reyes

    Just read the article on the difference between alpha and beta. It was explained in simple terms which I now can use with participants. Thank you for making it easy to understand. I look forward to reading more articles from you.

  • Gowthami

    Really wonderful….Simple and clear..Thank u :)