Mutual Funds 101: What the Beta Are You Talking About?

Diversification, S&P 500, Dow Jones and the beta are terms related to investments. They sound fancy and sophisticated, but really they are not.

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My wife and I invest in mutual funds. They are spread out among various 401k and IRA’s. Since we have multiple accounts and multiple funds to chose from, we use various tools to guide our purchase decision. ONE of those tools is the “beta.”

What is Beta?

The beta is a measure of systematic risk and should be used for a diversified portfolio. Where systematic risk is the type of risk that can affect the entire stock market such as political events, inflation, or currency exchange changes like the value of the dollar.

A diversified portfolio means that your investments are spread around or not all in “one basket.”

The Beta measures the volatility of a stock or mutual fund in relations to the market. In most cases, the market is measured using the S&P 500. The S&P 500 is made up of 500 stocks and is a pretty large representation of the stock market.

The beta of the S&P 500 is 1.00. Stocks and mutual funds beta can be lower, even with, or higher than the S&P 500. For example, if a mutual fund has a beta of 1.30, it means than when the S&P 500 is up, this mutual fund is up, but most likely will have moved higher than the S&P 500.

This holds true if the market goes down; a mutual fund with a beta of 0.75 will most likely go up when the market is up, but not as high, but if the market goes down, it will go down, but not as far.

Why is this Important?

When selecting mutual funds, you want to maintain a diversified portfolio. This may include spreading out your investments across funds with various risks and volatility (beta).

You don’t want all of your funds invested in betas above 1.00 because when the market goes down, your investments will all go down but probably more than the market.

Below is a list of four mutual funds I own in a Roth IRA with their betas:

  • Amana Mutual Fund Trust Growth= 0.90
  • Driehaus Emerging Markets= 0.93
  • Gabelli Asset Fund= 1.03
  • BMO Small Cap Growth= 0.99

I have my money spread evenly across all four funds, the average beta for this portfolio is about 0.96. Close to the performance of the market but not riskier than the market.

Keep in mind that beta is not the only measure you use when selecting a mutual fund. There are various things you need to look at like the tenure of the fund manager, historical returns, type of fund, and expenses. This is not all-inclusive.

If you are someone who prefers to let a broker select your investments, it is still important to know some of these concepts. Your broker should be able to explain this to you. If not, then you need a new broker; one that not only invests your money, but educates as well.

Question: What is the beta of your mutual fund or stock holdings? Is your portfolio to risky or too conservative? Please share.