Using Beta To Evaluate Volatility And Risk Can Help You Choose The Best Mutual Funds.
Beta compares volatility and is another important measure to use in order to choose the best mutual funds.
Beta is a measure of sensitivity to market changes.
It compares a specific mutual fund's sensitivity to market changes to the overall stock market's sensitivity to market changes.
The beta of the overall stock market is always equal to "1", regardless of how erratic or serene the market may be.
Every fund's beta is, therefore, a comparative measure against the number "1".
Given that reference, if a mutual fund has a beta of "2", that means that it has been twice as volatile (sensitive to market change) as the overall stock market has been over a certain period of time.
Or, put another way, historically when the market moved up by say 5%, the fund moved up by 10%. The same happened when the market moved down by 5%, the fund moved down by 10%.
Likewise, a fund, whose beta is ".5", has been half as volatile as the overall stock market. Therefore, historically this ".5" beta fund changed half as much as the market changed.
Comparing one mutual fund's beta to the beta of another mutual fund provides you a side by side comparison of each funds sensitivity to market fluctuations.
It also gives you a comparative indication of how much risk was taken by each fund individually to produce it's performance results.
Comparing the average returns and betas of different funds and fund classes helps you to evaluate risk and will, therefore, help you to choose the best mutual funds.
Here is an example...
Let's say that the average annual return for a "stock fund" for a certain time period was 15%. During that same period, the average annual return for a "balanced fund" was 10% per year.
At first glance, the "stock fund" looks like the superior investment, wouldn't you say?
But, when you consider that the beta of the "stock fund" was 1, and the beta of the "balanced fund" was .5. What that means is that... the "balanced fund" earned two thirds (67%) of what the "stock fund" earned, but did so while taking on only half as much risk as the "stock fund".
In this example, the "balanced fund" represents a better risk/reward ratio and might therefore be the better choice.
You should take on only as much risk as necessary to obtain your goal.
Comparing a mutual fund's beta to the beta's of other funds gives you a good comparison of the amount of risk the fund has taken to obtain it's past performance.
A low beta indicates that the fund's market-related risk is low.
Look for funds that have not only provided acceptable performance results, but have done so with less volatility and risk.
"Because It Matters"... Jim
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