# What Beta Means for Investors

> **Definition**
>
> Beta is a widely used indicator of the price volatility, or the level of risk, of a stock relative to the broader market.

## What Is Beta?

Beta is an indicator of the price volatility of a stock or other asset in comparison with the broader market. It suggests the level of risk that an investor takes on in buying the stock. The higher the beta number, the higher the risk.

The market that the stock trades in, such as the S&P 500, always has a beta of 1.0. A number above one indicates that the stock's price swings more, up or down, than the market in general. A number below one indicates its price is more stable.

The current beta of any stock can usually be found on the summary page of its listing on any financial website or stock trading site.

### Key Takeaways

*   Beta gets its name from the second letter of the Greek alphabet, the letter (β).
*   Conventional wisdom says that stocks with a higher degree of risk have a higher chance of outperforming the markets.
*   Investors who aim for a balanced portfolio might include both stocks that have a high beta and stocks that have a low beta.

![Beta](https://www.investopedia.com/thmb/EuoiCsbidRDdGqTnLps5ycTsNVY=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/BETA-FINAL-9a06ac0fc2d84589aded1475150869c2.jpg)

*— Investopedia / Yurle Villegas*

## How Beta Works

A [beta](https://www.investopedia.com/terms/b/beta.asp) coefficient shows the volatility of an individual stock compared to the systematic risk of the entire market. Beta represents the slope of the line through a regression of data points. In finance, each point represents an individual stock's returns against the market.

Beta effectively describes the activity of a security's returns as it responds to swings in the market. It is used in the [capital asset pricing model](https://www.investopedia.com/terms/c/capm.asp) (CAPM), which describes the relationship between systematic risk and expected return for assets. CAPM is used to price risky securities and to estimate the expected returns of assets, considering the risk of those assets and the cost of capital.

## Calculating Beta

A security's beta is calculated by dividing the product of the [covariance](https://www.investopedia.com/terms/c/covariance.asp) of the security's returns and the market's returns by the [variance](https://www.investopedia.com/terms/v/variance.asp) of the market's returns over a specified period. The [calculation](https://www.investopedia.com/articles/investing/102115/what-beta-and-how-calculate-beta-excel.asp) helps investors understand whether a stock moves in the same direction as the rest of the market. It also provides insights into how volatile—or how risky—a stock is relative to the rest of the market.

For beta to provide useful insight, the market used as a [benchmark should be related](https://www.investopedia.com/ask/answers/102714/how-do-you-calculate-beta-excel.asp) to the stock. For example, a bond ETF's beta with the S&P 500 as the benchmark would not be helpful to an investor because bonds and stocks are too dissimilar.  

$\begin{aligned} &\text{Beta coefficient}(\beta) = \frac{\text{Covariance}(R_e, R_m)}{\text{Variance}(R_m)} \\ &\textbf{where:}\\ &R_e=\text{the return on an individual stock}\\ &R_m=\text{the return on the overall market}\\ &\text{Covariance}=\text{how changes in a stock's returns are} \\ &\text{related to changes in the market's returns}\\ &\text{Variance}=\text{how far the market's data points spread} \\ &\text{out from their average value} \\ \end{aligned}$

## Beta Values

*   **Beta equal to 1:** A stock with a beta of 1.0 means its price activity correlates with the market. Adding a stock to a portfolio with a beta of 1.0 doesn’t add any risk to the portfolio, but it doesn’t increase the likelihood that the portfolio will provide an excess return.
*   **Beta less than 1:** A beta value less than 1.0 means the security is less volatile than the market. Including this stock in a portfolio makes it less risky than the same portfolio without the stock. Utility stocks often have low betas because they move more slowly than market averages.
*   **Beta greater than 1:** A beta greater than 1.0 indicates that the security's price is theoretically more volatile than the market. If a stock's beta is 1.2, it is assumed to be 20% more volatile than the market. Technology stocks tend to have higher betas than the market benchmark. Adding the stock to a portfolio will increase the portfolio’s risk, but may also increase its return.
*   **Negative beta:** A beta of -1.0 means that the stock is inversely correlated to the market benchmark on a 1:1 basis. [Put options](https://www.investopedia.com/terms/p/putoption.asp) and [inverse ETFs](https://www.investopedia.com/terms/i/inverse-etf.asp) are designed to have negative betas. There are also a few industry groups, like gold miners, where a negative beta is common.

## How Investors Use Beta

An investor uses beta to gauge how much risk a stock adds to a portfolio. While a stock that deviates very little from the market doesn’t add a lot of risk to a portfolio, it also doesn’t increase the potential for greater returns.

Investors must ensure that a specific stock is compared to the right benchmark and review the R-squared value relative to the benchmark. [R-squared](https://www.investopedia.com/terms/r/r-squared.asp) is a statistical measure that compares the security's historical price movements to the benchmark index.

A security with a high R-squared value indicates a relevant benchmark. A gold [exchange-traded fund](https://www.investopedia.com/terms/e/etf.asp) (ETF), such as the SPDR Gold Shares ([GLD](https://www.investopedia.com/markets/quote?tvwidgetsymbol=gld)), is tied to the performance of gold bullion. Consequently, a gold ETF would have a low beta and R-squared relationship with the S&P 500.

Investors commonly evaluate two categories of risk. Systematic risk is the risk of the entire market declining, also known as undiversifiable risk. [Unsystematic](https://www.investopedia.com/terms/u/unsystematicrisk.asp), or diversifiable risk, is the uncertainty associated with an individual stock or industry. It is the risk related to a company or sector and can be mitigated through diversification.

> **Fast Fact**
>
> A stock's beta will change over time as it relates a stock's performance to the returns of the overall market.

## Theory vs. Practice

The beta coefficient theory assumes that stock returns are normally distributed from a statistical perspective. In reality, returns aren’t always normally distributed. Therefore, what a stock's beta might predict about a stock’s future movement may prove untrue.

A stock with a very [low beta could have smaller price swings](https://www.investopedia.com/articles/investing/082515/how-aqr-places-bets-against-beta.asp), yet still be in a long-term downtrend. So, adding a down-trending stock with a low beta decreases the risk in a portfolio only if the investor defines risk strictly in terms of volatility and not potential losses.

Similarly, a high beta stock that is volatile in a mostly upward direction will increase the risk of a portfolio, but it may increase gains. Investors who use beta to evaluate a stock also evaluate it from other perspectives, such as fundamental or technical factors, before assuming it will add or remove risk from a portfolio.

## Is Beta a Helpful Measure for Long-Term Investments?

While beta can offer useful information when evaluating a stock, it does have some limitations. Beta can determine a security's short-term risk and analyze volatility. However, beta is calculated using historical data points and is less meaningful for investors looking to predict a stock's future movements for long-term investments. A stock's volatility can change significantly over time, depending on a company's growth stage and other factors.

## Is Beta a Good Measure of Risk?

Beta can provide some risk information, but it is not an effective measure of risk. Beta only looks at a stock's past performance relative to the S&P 500 and does not predict future moves. It also does not consider the fundamentals of a company or its earnings and growth potential.

## How Do Investors Interpret a Stock's Beta?

A Beta of 1.0 for a stock means it has been as volatile as the broader market. If the index moves up or down 1%, so too would the stock, on average. Betas larger than 1.0 indicate greater volatility. So if the beta were 1.5 and the index moved up or down 1%, the stock would have moved 1.5%, on average. Betas less than 1.0 indicate less volatility; if the stock had a beta of 0.5, it would have risen or fallen just half a percent as the index moved 1%.

## The Bottom Line

Beta (β) is the second letter of the Greek alphabet used to measure the volatility of a security or portfolio compared to the S&P 500, which has a beta of 1.0. A Beta of 1.0 shows that a stock has been as volatile as the broader market. Betas larger than 1.0 indicate greater volatility, and betas less than 1.0 indicate less volatility.  

> **Article Sources**
>
> 1.  World Gold Council. "[GLD SPDR Gold Shares](https://www.spdrgoldshares.com/usa/key-information/)."