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| Q. On television and in the
newspaper I keep hearing about an investment term called beta. Could you please
tell me what exactly beta is, and how it works? G.M.
Clarksville, IN
A. Basically Beta is measurement of risk one has in his or her stock or stock mutual fund investment portfolio. Beta is calculated by comparing the returns of the Standard & Poor's 500 (S&P 500) to the returns of a particular stock or mutual fund. From this comparison, a pattern develops that indicates the security's exposure to stock market risk.The S&P 500 is an unmanaged index generally considered representative of the U.S. stock market and has a beta of 1.00. A beta of 1.00 means that, on average, the investment moves parallel to the S&P 500--if the S&P 500 rises 15%, the investment will rise 15%; if the S&P 500 declines by 15%, the investment will decline 15%. A beta greater than 1.00 indicates that when the stock market rises or falls, the investment will rise or fall to an even greater extent. A beta less than one indicates that when the stock market rises or falls, the investment will rise or fall to a lesser extent than the S&P 500. It is important to keep in mind that beta measures movements on average; thus you cannot expect an exact correlation with each movement in the market. Before using beta as a tool to evaluate your portfolio, it is important to understand its limitations. Beta is a measure of stock market risk and does not measure other types of risk. For instance, if your portfolio is not diversified, you face other risks that are not reflected in beta. A beta for a bond or bond fund is not a useful measure since it relates the return of the bond fund to the return of the stock market. For bonds, a more significant risk than market risk is interest rate risk. Q. What are the advantages and disadvantages of investing in individual stocks versus a mutual fund? --J.G. Jeffersonville, INA. Investing in stocks allows for more opportunity to be involved in the investment process by selecting individual stocks that appeal to you for one or more reasons. Stocks are also an opportunity for you to focus on investments in a particular area or direction. One disadvantage of individual stocks is that they bear substantial risks, especially if one's investment portfolio is not diversified. Mutual funds on the other hand offer both professional management and a level of diversification that is difficult for individual investors, particularly small investors, to achieve on their own. It is very likely that a single fund could invest in over 100 separate stocks, and an investor in that particular fund would have part ownership in all of the underlying stocks. Investing in a high number of stocks in different industries and markets offers great diversification to the investor. Some mutual funds further diversify their investments into stocks, bonds, Government Securities, and cash or some combination thereof.
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