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Beta Market Risk-What You Need To Know
A common question I answer about investing is, “I’ve heard the term Beta before, but what is it and how does it affect me”. In this article I’m revealing why it’s important for you to understand what Beta is?
It’s important for you to understand what Beta is because you want to know the amount of risk you are taking inside your investment portfolio in order to earn profit on your investment. I can’t give you an exact percentage of how many people don’t understand what Beta is. But, I’ll tell you from experience that most people who come through our doors, that need help with retirement planning, have no idea what the word Beta means.
What Does Beta Mean?
So, what does it mean? Beta is just a simple word that our industry substitutes in replacement of the word risk. Let me give you a quick example. We are often asked to complete model portfolios comparison and we recently completed a model portfolio comparison comparing the model portfolio that someone was currently using, as opposed to one of our model portfolios.
When we got finished doing the comparison, the couple came into the office and we looked at the report. At first glance, things were exactly equal, meaning the returns that they were receiving were exactly equal to what we were experiencing and I could see it in their eye when they saw those numbers they were just about to say thank you, and walk out the door and continue to do what they were doing. But, before they could, I asked them a very simple question. “Mr. and Mrs. Jones do you understand the amount of risk your taking inside your current investment portfolio, as opposed to the amount of risk you could be taking with our investment portfolio?” They had no idea.
So, we flipped the page and we looked at Beta, or the measurement of risk. Now, when we looked at their model portfolio we saw very clearly that their current model portfolio, not only was is it out of line with what their risk tolerance was, but it was much higher than what we were reporting for the same exact return.
So, let me ask you a question with all things being equal with returns, if you were able to get a 10% return taking on a high amount of risk as opposed to get a 10% return with taking a low amount of risk, which would you prefer? Just about everyone that I work with would say, I’d rather take less risk to get the same return. That’s why it is really important that you understand how much Beta you have inside your investment portfolio.
So, how do you find it? There’s many ways to find it and here’s where you won’t find it. You won’t find it on your brokerage statement and you won’t find it in your quarterly reports. You can find what Beta would be, or the aggregated Beta of you investment portfolio, through a Morningstar report. If you have individual holdings, Morningstar also does reports of what individual securities Beta numbers are. I like Morningstar because they are independent and third party and do provide reporting on all the securities that are offered to investors that are out there.
Where Does Beta Hit You In The Pocketbook?
So, where does it hit you in pocketbook? If we had a Beta of 1.0 than you would know that you are taking on the same amount of risk in that security with the benchmark that it is compared against. So, if the underlying benchmark went up by 10% than you know that security it’s being compared against should also go up 10%. On the flip side, the more important thing that most people want me to help them understand is, what would happen on the down side? Well, if we had a Beta of 1.0 and the benchmark lost 10% than we could assume that underlying security might also lose 10%. So, if you’re the person that is risk adverse, then you want to be looking for a Beta less than 1.0. So, if you found a security that had a Beta of .75 than you would know inherently that particular security is 25% safer than the benchmark mark that it’s being compared against.
So, dollars and cents, really quickly, here’s the punch line. Pay attention. If you had a million dollar portfolio and a security that your looking at or your portfolio aggregated had a Beta of 1.0 and that benchmark lost 10% you would assume that you might lose $100,000 bucks. That’s pretty bad. But, if you had a Beta of .75 you might lose $75,000 dollars if that benchmark retracted by 10%. Thereby keeping $25,000 dollars more in your pocket and that’s.
You want to follow one of the most important principles in investing which is to get the highest amount of profit for the lowest amount risk.
Not only is it important what you make, but also, more importantly, it is what you keep! There you go. There you have it. That’s the definition of why it’s important to understand the Beta inside your investment portfolio.
To request a Portfolio Risk Analysis please contact Solid Wealth Advisors at 970-229-1616 or visit http://www.SolidWealthAdvisors.com