Like many retail investors, I've heard the terms Alpha and Beta used to describe individual stocks, sectors or styles of investment. Most investors realize that investments require a balancing act between risk and reward. Some also understand that higher risk means higher potential reward. Alpha and Beta are terms to help measure that balancing act.
Alpha represents the risk-adjusted return on an investment. Does your portfolio manager use benchmarks to help you put performance in context? If so, and if they use appropriate benchmarks for the risk inherent in their investment decisions, the performance against benchmarks is alpha. If a portfolio of investments has under performed (alpha < 0) that means you've earned too little for the risks taken. Most fund managers underperform the underlying market (S&P 500). However most, perhaps wrongly, argue that they don't underperform their benchmark. Their premise being: If they take less risk they will underperform in bull markets while losing much less in bear markets. That requires an understanding of Beta.
Beta has to do with relative movement or volatility. If a stock has a Beta = 1, the price moves in sync with the market. A positive Beta means higher volatility with the stock price moving more than the market. Conversely a negative Beta means less volatility and price movement.
Summary: Seeking Alpha is a great name. We all should want to earn more relative to the risk taken. Make sure your portfolio manager is judged the same way.
- Index investment is a way to get to market risk and reward. If fund managers are using the S&P 500 as their benchmark, they better show they have a negative beta to justify their fees.
- Individual investors that judge their performance by the S&P (my approach) should similarly understand the beta of their portfolio. We're all relatively poor market timers so don't think a high beta portfolio won't hurt when markets turn. If you're comfortable with concentrated positions (less diversification) and more volatility, make sure you are getting paid for it by outperforming the market on a consistent basis.
The more I think about it..Seeking Alpha is a worthy name for a website and even more worthy as a measuring stick.