Risk Measure: Beta

Beta is a relative risk measurement, because it depicts a security's volatility against a benchmark. It's common that professionals calculate betas for stocks using the S&P 500 index as the benchmark. You should calculate betas using a security's best-fit index. 

Beta is fairly easy to interpret. The higher a fund's beta, the more volatile it is relative to its benchmark.

  • In theory, a beta of 1.0 means that the security moves in tandem with it's benchmark. If the market goes up 10%, the security should go up 10%; if the market drops 10%, the security should drop by an equal amount.  
  • A beta that is greater than 1.0 means that the security is more volatile than the benchmark index. Say a security with a beta of 1.1 would be expected to gain 11% if the market rises by 10%, while a 10% drop in the market should result in an 11% drop by the security.  
  • A beta of less than 1.0 means that the security is less volatile than the index. For instance, a security with a beta of 0.9 should return 9% when the market went up 10%, but it should lose only 9% when the market dropped by 10%.  

The biggest drawback of beta is that it's really only useful when calculated against a relevant benchmark. If a security is being compared to an inappropriate benchmark, its beta is meaningless. Therefore when considering the beta of any security, you should examine another statistic: R-squared. The lower the R-squared, the less reliable beta is as a measure of the security's volatility. The closer to 100 the R-squared is, the more meaningful the beta is. Unless a security's R-squared against the index is 75 or higher, disregard the beta.