Investors use a statistical regression analysis to calculate the beta coefficient or beta of a mutual fund portfolio. They then use beta as a measure of risk and volatility. Investors also use the beta coefficient as a performance measure, comparing the mutual fund’s performance against the performance of either the stock market as a whole, or an index such as the S&P 500.
Investors typically give the stock market as a whole and the S&P 500 Index a beta value of one. Investors calculate beta values for a mutual fund by examining the fund’s historic price movements over a period, usually three to five years. The beta value of the mutual fund portfolio is either less than or greater than one. Investors then compare the fund’s beta to the overall stock market beta of one.
Risk and Return
Mutual fund portfolios with a beta value greater than one means that it has the potential to earn higher returns than the overall stock market. A value greater than one also means the fund possesses a potentially higher investment risk. A mutual fund with a beta value of less than one means that it has the potential to earn lower returns than the overall stock market, but can also mean that it possesses a lower investment risk.
A beta value measures the price movements of the mutual fund in relation to price movements of the overall stock market. It also measures how a mutual fund’s value reacts to changes in the stock market. If a mutual fund has a beta value of more than one, then investors typically consider it more volatile, as compared to the stock market as a whole, than a mutual fund with a beta value of less than one. Beta values are a type of measure of a fund’s volatility only compared to the stock market or the index as a whole. It does not directly measure the volatility of the mutual fund itself.
Investors measure the volatility of the mutual fund itself by using the fund’s standard deviation over a short period. When calculating the standard deviation, investors compare the rate of return of the fund over a period, generally three to five years of the fund. They then compare this to the fund’s long-term average rate of return. The more the current rate of return deviates from the long-term average, the more volatile the fund. The less it deviates, the less volatile the fund.
Sue-Lynn Carty has over five years experience as both a freelance writer and editor, and her work has appeared on the websites Work.com and LoveToKnow. Carty holds a Bachelor of Arts degree in business administration, with an emphasis on financial management, from Davenport University.