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Strategies & Market Trends : Portfolio Explorer: Risk Analysis & Luck -- Ignore unavailable to you. Want to Upgrade?

To: portfolioexplorer who wrote (1)	12/6/1999 10:44:00 PM
From: portfolioexplorer	Read Replies (1) \| Respond to of 4

Continuing on with the subject of risk analysis, many investors like to adjust returns for beta instead of defining risk as the chance of losing money. Beta describes the tendency of a portfolio to move in lockstep (on average) with the rest of the market. A portfolio with beta = 0 is not correlated with the market. Beta = 1 means that it moves together with the market. A portfolio with beta = 2 moves up and down twice as hard. A negative beta means that the portfolio actually moves in the opposite direction from the market. So how does this play out? While a stock with a beta=1 does not have a graph that looks like the S&P - it can jump all over the place. But a portfolio made up of a lot of stocks with beta=1 will. So while this stock by itself will have a lot of movement, it only "deserves" the return associated with the risk - as defined by beta. Otherwise, you could take a portfolio made up of a ton of stocks like this one (which would only move around as much as the market) and make more money than the market. Moving back to the real-life example of the Motley Fool portfolio, the MF port made 68.7% annually vs. the S&P's 25.4%. However, the MF port had beta = 1.4, making it more risky by this measure. If we adjust the S&P to have beta = 1.4, it gets a better return with the extra risk. Instead of 25.4%, it makes 34.4%. Not enough to beat the MF, but makes it closer. Portfolio Return Beta Fool 68.7% 1.4 S&P 500 25.4% 1.0 Beta-Adj S&P 34.4% 1.4