Alpha and beta are commonly used measures to judge the past performance of a stock, investment fund or investment portfolio. Both numbers are helpful for investors, but do not necessarily help predict how an investment will perform in the future.
Alpha
Put simply, alpha measures a company’s or a portfolio manager’s ability to outperform the market. “Alpha measures the return on an investment above what would be expected based on its level of risk,” Brian Baker, CFA. That is usually calculated by comparing returns with a benchmark index, like the S&P 500, over a particular period of time.
The difference between an investment’s return and the benchmark index is the investment’s alpha. Sometimes this is called “excess returns” or “abnormal rate of return” when adjusted for risk.
“It’s usually a single number, such as +2 or -1, representing the percentage an investment returned above or below a related benchmark index,” stated. “A positive alpha means the investment outperformed the benchmark index, while a negative alpha shows it underperformed.”
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“A high alpha is always good,” according to .
Alpha “is the result of active investing, Investopedia . “Beta, on the other hand, can be earned through passive index investing.”
Beta
Beta brings risk into the equation. “Beta measures an investment’s volatility compared to the overall market,” for example, a benchmark index like the S&P 500, noted .
In other words, a stock or fund with a higher beta has a higher rate of , which means its price can move up or down by a notable amount suddenly and not necessarily in the same direction or at the same pace as the overall market.
According to : “The baseline number for beta is one, which indicates that the security’s price moves exactly as the market moves. A beta of less than 1 means that the security is less volatile than the market, while a beta greater than 1 indicates that its price is more volatile than the market. If a stock’s beta is 1.5, it is considered to be 50% more volatile than the overall market. Like alpha, beta is a historical number.”
A high or low beta coefficient indicates that the price is not moving in sync with the overall market. A high or low beta is neither good nor bad.
For example, investors looking to grow their portfolio aggressively might select some stocks or funds with a high beta and hope the higher rate of risk pays off with outsized performance. On the other hand, an investor seeking stable returns will probably opt for stocks or funds with a beta closer to one.