How Do You Calculate Portfolio Beta?
How Volatile Is Your Investment Portfolio?
Perhaps the most important thing to consider when building an investment portfolio is your level of diversification. It’s crucial that you try and spread your investments across a broad number of companies, industries, sectors, and asset classes so you aren’t too heavily impacted by one market event.
Diversification can help make your portfolios less volatile, allowing you to see steady growth without seeing wild swings in the value of your savings.
How Volatility or Beta Is Calculated
First, it’s important to understand that beta is measured on a scale comparing the investment to a benchmark index. A beta of “1” indicates that its volatility is like the benchmark’s. A number higher than “1” indicates more volatility, while lower numbers indicate more price stability.
Most major stocks compare their beta to that of the S&P 500. In general, high-growth stocks, small cap stocks, and those in the technology sector tend to have higher beta. Companies in the consumer staples sector, utilities, and manufacturers tend to have lower beta.
Individual investors can determine the volatility of their whole portfolios by examining the beta of each holding and performing a relatively simple calculation. The calculation is simply a matter of adding up the beta for each security, and adjusting according to how much of each you own. This is called a weighted average.
Steps to Calculate Beta for a Stock Portfolio
The beta for individual stocks is readily available on the websites of most online discount brokerages or reliable publishers of investment research. To determine the beta of an entire portfolio of stocks, you can follow these four steps:
- Add up the value (number of shares x share price) of each stock you own and your entire portfolio.
- Based on these values, determine how much you have of each stock as a percentage of the overall portfolio.
- Multiply those percentage figures by the appropriate beta for each stock. (Thus, if Amazon comprises 25% of your portfolio and has a beta of 1.43, it has a weighted beta of 0.3575.)
- Add up the weighted beta figures.
Let’s illustrate this by calculating the beta on this fictional portfolio of six stocks.
|Total Portfolio Value: $100,000|
|Stock||Value||Share of Portfolio||Beta||Weighted Beta|
|Procter and Gamble||$18,000||0.18||0.6||0.108|
As you can see, adding up the weighted beta figures in the right column results in a beta of about 1.01. Thus, this portfolio has a volatility very much in line with the S&P 500.
Reasons to Calculate Beta for Individual Stocks
Most investors won’t have much occasion to calculate beta for individual stocks, as those figures are readily available. However, there may be times when an investor will find it useful to crunch numbers themselves.
It’s important to understand that beta can be calculated over various time periods. Stocks can prove to be volatile over the short term but are generally stable over many years. For this reason, an investor may wish to calculate beta themselves to get a more precise answer.
Additionally, an investor may prefer to calculate beta by using a different benchmark. For example, you may believe that a stock with a heavy presence overseas is best judged against an international index instead of the S&P 500.
Calculating beta on your own can also be educational in that it allows you to examine price movements in great detail.
How to Calculate Beta on a Spreadsheet
Some models for calculating a stock’s beta are very complex, but we’ll use the most straightforward approach here.
To begin, you’ll likely need a spreadsheet program to assist with calculations. Then you should determine the range of time you intend to measure.
Using the spreadsheet program, enter the closing share price for your stock on each day of the date range you’ve selected. Then do the same thing for the index you are comparing against. For each date, determine the change in price and the change on a percentage basis.
At this point you’ll use a formula to determine how the stock and index move together and how the index moves by itself.
The formula is: (Stock’s Daily Change % x Index’s Daily % Change)/ Index’s Daily % Change.
The Bottom Line
You can determine the volatility or beta of your stock portfolio with basic math. But as an investor, you will need to keep in mind key differences between short-term and long-term risks for your portfolio. High betas can show stock prices going up and down in the short-term. But this does not mean that the same stock is not a good long-term investing opportunity.