In this article, we will learn how to calculate the beta coefficient for your investment portfolio and how you can measure its volatility. Diversifying investments is very important when building an investment portfolio. When you spread your investments across a large number of companies, industries, sectors, and asset classes, you may be less impacted by a single market event.
How to Calculate Beta?
The beta coefficient is measured on a scale that compares an individual investment to a benchmark index like the S&P 500. A beta of 1.0 indicates that its volatility is similar to the benchmark index. In other words, it moves in parallel with the benchmark index.
A number higher than 1.0 indicates more volatility than the benchmark index, while a number lower than 1.0 indicates more stability. For example, if you have a stock with a beta of 1.2, it means it is 20% more volatile than the market, meaning that if the S&P 500 drops by 10%, this stock is expected to drop by 12%.
You can determine your portfolio’s volatility by examining the beta coefficient for each stock and performing a relatively simple calculation. You just need to sum up the beta coefficients for each security and adjust it according to how much of each you own. This is called the “weighted average.”
Four Steps to Calculate Beta
The beta coefficient for individual stocks can be easily found on discount brokerage websites or reputable investment research publishers. To determine the beta for an entire stock portfolio, you can follow these four steps:
- Add the value (number of shares multiplied by the share price) for each stock you own and for your entire portfolio.
- Based on these values, determine how much you have of each stock as a percentage of the overall portfolio.
- Multiply those percentages by the appropriate beta coefficient for each stock. For example, if Amazon makes up 25% of your portfolio and has a beta of 1.43, it has a weighted beta of 0.3575.
- Add up the weighted beta numbers.
Let’s illustrate this by calculating the beta coefficient for this fictional portfolio consisting of six stocks:
| Stock | Value | Portfolio Share | Beta Coefficient | Weighted Beta |
|---|---|---|---|---|
| Amazon | $25,000 | 0.25 | 1.43 | 0.3575 |
| Walmart | $22,000 | 0.22 | 0.63 | 0.1386 |
| Netflix | $20,000 | 0.20 | 1.51 | 0.302 |
| Procter & Gamble | $18,000 | 0.18 | 0.60 | 0.108 |
| Coca-Cola | $9,000 | 0.09 | 0.42 | 0.0378 |
| 3M | $6,000 | 0.06 | 1.22 | 0.0732 |
| Total Weighted Beta | 1.0171 | |||
As can be seen, summing the weighted beta numbers in the right column results in a beta of approximately 1.01. This means that the volatility of this portfolio aligns perfectly with the S&P 500.
How to Calculate Beta for Individual Stocks
You may not have many reasons to calculate the beta for individual stocks, as those figures are readily available. However, there may be times you find it beneficial to calculate these numbers yourself.
It is important to understand that beta can be calculated over different time frames. Stocks may be volatile in the short term but are generally stable over many years. For this reason, you may want to calculate beta yourself to gain a more accurate answer.
You may sometimes prefer to calculate beta using a different benchmark. For example, you may think it’s better to evaluate a stock with strong international presence against an international index rather than the S&P 500.
Calculating beta yourself can also be educational as it allows you to examine price movements in great detail. Some models for calculating beta for stocks are very complex, but we will use the simplest method here. Follow these basic steps:
- To start, you will likely need a spreadsheet program to assist with the calculations. Then you should determine the time range you intend to measure.
- Use the spreadsheet program to enter the closing price of your stock for each day within the date range you specified. Do the same for the index you are comparing it to. For each date, determine the price change and the percentage change.
- Do
By entering the formula to determine how the stock and the index move together and how the index moves alone. The formula is: (daily percentage change of the stock × daily percentage change of the index) ÷ daily percentage change of the index.
Investors can use the beta coefficient as a way to assess the risk of a particular investment. For example, it can help understand what might happen to a stock with a beta coefficient lower than that of the market when the market experiences a downturn.
Frequently Asked Questions (FAQs)
What is the expected return rate for a stock with a beta of 1.0?
A stock with a beta of 1.0 has the same return rate as the market it is being compared to. For example, if you are comparing the stock to the S&P 500 index and it has a beta of 1.0, it will give you a return similar to the S&P 500 index.
What determines a stock’s beta?
The beta coefficient measures a stock’s volatility compared to the market, and there can be many reasons why a particular stock is more or less volatile. These reasons include the company’s performance, the company’s size, supply chain effects, speculative activity, and others.
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Source: https://www.thebalancemoney.com/how-to-calculate-your-portfolio-beta-4590382
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