Investment alpha is useful for investors because it gives them a way to truly understand how their assets are doing. The baseline number for alpha is zero, meaning the portfolio or stock is tracking perfectly with the benchmark index. Alpha is a historic measure, a positive alpha means the fund has historically outperformed the index, and a negative alpha means the fund has historically underperformed the index. For example, if a stock performs 3% better than the S&P 500, the alpha of that stock would be 3.
Specifically, alpha indicates the percentage below or above a benchmark index the stock achieved, but is represented as a single number. These two concepts are useful tools for every investor looking to make informed investment decisions.ĭiversify your portfolio with blue-chip artĪlpha measures the return on an investment compared to a market index or benchmark. Before investing, beta would tell an investor how well a potential investment mirrored the S&P 500 over its existence. If their investment’s growth outpaced the S&P 500, one would say it has achieved “alpha.”īeta measures the relative volatility of an investment compared to the market as a whole. For example, alpha might be the rate a recently purchased stock grew or diminished compared to the S&P 500 Index. Modern portfolio theory attempts to assure investors which investments have a higher likelihood of success, given the risks they are taking on.Īlpha measures the return on an investment in comparison to the market index or other broad benchmark. The MPT is a framework that uses the performance of investments to estimate the expected return compared to the level of risk. Alpha and beta are proponents of modern portfolio theory (MPT).
By calculating various risks, investors can make more educated decisions. Alpha and beta are two key risk ratios used to evaluate the performance of an investment asset.
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