Beta Investing Finance

Finance My portfolio was constructed out of six stocks that are all market leaders. I was looking at mutual funds but could not find beta information so I went with all stocks. Each stock has a beta, which reflects the risk that company has, specifically how the stock moves in line with the market.

This is not a causal relationship, just corollary -- the asset does not "react" to the market, it moves in line with investor expectations about its future, and the beta simply measures how those moves correspond with moves in the broad market. In this paper, I outline the portfolio, along with the individual betas for each security, and the weighting of each asset in the portfolio. One of the important steps in portfolio management is the calculation of the portfolio beta.

This is simply the weighted-average of the individual betas within the portfolio. A chart is provided to show how the total portfolio beta is 0.939, which is lower than the market beta of 1.0. This means that the portfolio is less volatile than the overall market. When the market declines, this portfolio should decline less. When the market increases, this portfolio should increase less. That is how beta is used to predict the behavior of assets on the market.

There is also discussion in this paper about what it means to have a bearish or bullish outlook -- these are not really related to beta, which is by definition a rational investing tool while "bear" and "bull" are emotional sentiments that detract from investor rationality. Further, the fallacy of the beta reacting to the market movements is explained, noting that there is no causal relationship between the markets and individual securities. My portfolio consists of six stocks, all market leaders.

These blue chip stocks are Apple (20%), Google (20%), Exxon Mobil (20%), Wal-Mart (20%), Starbucks (10%) and Goldman Sachs (10%). The portfolio components, with their betas and total portfolio beta follows. My Portfolio Security Beta Weight Apple 20 1.01 0.202 Google 20 1.15 0.23 Starbucks 10 1.18 0.118 Exxon Mobil 20 0.73 0.146 Goldman Sachs 10 1.69 0.169 Wal-Mart 20 0.37 0.074 0.939 The total portfolio beta is a weighted-average of the betas of the individual securities in the portfolio.

So the weight for Apple is: (.2)*(1.01) = 0.202 The same calculation is completed for all of the components of the portfolio, and then these figures are added up to get the weighted average beta, which is the overall beta for the portfolio. Note that the portfolio's beta is trending towards 1.0, which is the baseline market beta. There are two companies in this portfolio that have a low beta, and 20% of the portfolio is in each one. This offsets the high beta for Goldman Sachs, which is just 10% of the portfolio.

The result is that these low beta securities -- especially Wal-Mart -- bring the beta of the overall portfolio down below one, meaning the portfolio is going to move at a lower degree of amplitude to the overall market. What this means is that if the S&P experiences a 10% decline from today's value, the portfolio will move as follows: (-10)(.939) = -9.39% The portfolio will decline 9.39% if the S&P declines 10%. The portfolio therefore does not go down as far as the market.

The same principle applies to the portfolio if the S&P increases -- the movement is not as pronounced as the movement in the market. If the S&P increases 20% the portfolio would change as follows: (+20)(.939) = +18.78% The portfolio is not a "bear" or a "bull" -- the portfolio is a portfolio that seeks to have a lower degree of risk regardless of what my views are on the future direction of the market. Indeed, rationality.