Stocks with a Negative Beta

Posted by Rebekkah On May - 2 - 2013 0 Comment

When constructing a stock portfolio, it’s tempting to only pick stocks that have the highest potential return. However, it’s equally important to focus on a stock’s risk. Every stock has exposure to two types of risk. Non-systematic risk includes risks that are specific to a company or an industry. Most non-systematic risk can be eliminated through diversification across companies and sectors. The second type of risk is systematic risk, which refers to risks that affect the entire stock market. Systematic risk can’t be eliminated through diversification, but it can be managed via a risk measure called beta.

What is Beta?

Beta measures a stock’s risk in relation to the overall market. A stock with a beta of one has the same level of risk as the overall market. In a rising market, the stock’s price increases. In a falling market, the stock’s price will fall. A stock with a beta greater than one has more risk and volatility than the market. It will move with the market, but will move to greater extremes. In an increasing market, the stock’s price will advance at a faster rate than the market. However, in a falling market, the stock’s price will drop further and faster. Stocks with a beta of less than one will move with the market to an extent, but with less volatility. A beta of zero means the stock has no relationship with the market at all.

What Does a Negative Beta Mean?

Some stocks have a negative beta, which means that the stock will move in the opposite direction of the stock market. These stocks are rare, but they do exist. Many companies related to gold investing have negative betas because gold and the stock market have historically moved in opposite directions. Companies that do most of their business overseas, especially in fast-growing countries in South America or Asia, may have a negative beta because their business isn’t directly linked to the United States economy. Also, exchange-traded funds that focus on “shorting” stocks can have negative betas. Shorting a stock is speculating that the stock’s price will go down. Since these types of exchange-traded funds profit when the market drops, it makes sense that they would have a negative beta.

Should Negative Beta Stocks be Included in a Portfolio?

There’s no right or wrong answer as to whether a negative beta stock should be included in a portfolio. The question depends on what the investor wants to achieve. A portfolio built to aggressively grow in value with little regard for risk should include stocks with betas greater than one. A negative beta stock would be out of place in that portfolio. However, a portfolio designed to mitigate risk and limit losses should have lower beta investments. Negative beta stocks could have a place in that portfolio.

It’s important to remember that a negative beta stock does have a relationship to the stock market. It moves in the opposite direction. In a falling market, the negative beta investments will provide a hedge because they will increase in value. However, in a rising market, the negative beta investments will fall in value and become a drag on the portfolio. Negative beta stocks can add value to a portfolio, but they do come with their own set of risks.

ABOUT THE AUTHOR:

This article was provided to eFinancial Resource Center by Richard Craft, an MBA student who looks forward to helping you make better decisions financially. He writes this on behalf of KEL Credit Repair, your number one resource when looking to fix your credit score. Check out their website today to see how they can help you!  To find out more about guest publishing on our blog, please visit our Guest Posting page.

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