While these risk ratios cannot always accurately predict future results, alpha and beta help to differentiate between good and bad investments over a given period of time.
Alpha is perceived as a measurement of a portfolio manager's aptitude. Alpha measures the return that comes from investing in a single security or investment class. Meanwhile, beta gauges the volatility of a specific security by comparing it to the performance of a related benchmark over a period of time. Beta measures the return generated from a portfolio that can be attributed to overall market returns.
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The baseline number for alpha is zero, which is when the investment performed exactly to market expectations. However, the baseline number for beta is one. A beta of one is an indication that the security's price moves exactly as the market moves, Cortazzo explains. If the beta is less than one, the security experiences less severe price swings than the market. Conversely, a beta above one means that the security's price has been more volatile than the market as a whole, he says.
As an investor, it's very important to take the time to get a grasp of financial strategies, Cortazzo says.