Beta is a term used to measure the correlation of volatility of a portfolio against the index in which it resides. The market has a Beta of 1 since it IS the market. Your portfolio would be more volatile than the market if it had a Beta higher than 1. Conversely, if your portfolio had a Beta of less than 1, it means that you have less volatility than the market.
As an example, let’s say that you owned 20 stocks found in the S&P 500 and that the index (the S&P 500) returned 10% over the last 5 years. If your portfolio returned 10% but had a Beta of 0.5 than your portfolio (from a risk versus return point of view) was better than holding the index. This is because your portfolio had HALF the volatility of the index, yet produced similar returns.
Beta is useful information (and widely available information) when looking at mutual funds. If you see a mutual fund that has the same 10 year return as the market but the Beta is 1 or higher, is it worth owning? If you can find a fund that matches or exceeds market performance with a Beta below 1, than that would be a much better choice since your risk-adjusted returns would be higher – or in other words, you are getting all the returns, with less volatility!
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