As any roller coaster enthusiast knows, there’s nothing quite like the thrill of a steep unexpected drop or the weightless excitement of arcing over a peak.
But that’s not the kind of thrill I’m looking for in the stock market.
Sure, volatility can open a window for investors to buy low on undervalued companies, but, much like riding a roller coaster, you don’t want to experience it 24/7.
And with seemingly endless political and global uncertainty, volatility is rearing its ugly head again, as we saw in July and August.
So what’s an investor to do? After all, since the stock market is the best place to build a retirement portfolio over time, it’s important to keep safety—as well as growth—in mind.
One strategy that is worth keeping in mind is investing in low-beta stocks. They can help you maintain your exposure to equities, but they “pump the brakes” on the volatility because they don’t move as much as the market does.
What Are Low-Beta Stocks?
The definition of beta is simple—it compares the volatility, or systemic risk, of a stock to the volatility of the market. In other words, it measures a stock’s response to market swings.
If a stock has a beta of 1, that means the price of that stock generally moves with the market. Less than 1 means the stock is less volatile than the market. And more than 1 means it’s more volatile than the market.
Here are a couple of examples:
- A beta of 1.3: The stock is deemed to be 30% more volatile than the market. If the market goes up 10%, the stock should, theoretically, rise by 13%. And if the market declines 10%, the stock should decline by 13%.
- A beta of 0.5: The stock is expected to be half as volatile as the market. If the market rises by 10%, this stock should go up by 5%. And a market decline of 10% should result in a decline of just 5% for the stock.
And there are potentially some stocks with a negative beta—a beta less than 0. They demonstrate an inverse relationship with the market. So, if the market falls, a negative beta stock is expected to rise. One thing about negative betas—they are rare and usually short-term in nature, and will often reflect industry conditions more than market volatility.
Cash has a beta of 0, and low-beta stocks and investments include utility stocks and Treasury Bills.
You can find a security’s beta on many of the available financial websites, including Yahoo! Finance. Just type in the symbol of your stock and it comes up on the first screen. Keep in mind that the beta quoted is a “historical” average and doesn’t mean the stock’s volatility measure will remain the same in the future. In fact, empirical studies have shown that higher betas tend to decline back toward 1 and lower betas tend to rise toward 1, over time.
If you’re interested in screening for low-beta stocks, a stock screener like Finviz is a convenient way to do it (you can find beta under the “Technical” tab).
And it’s important to know that beta is a measure of systematic or market risk, and doesn’t tell us anything about the specific risk of the company itself. That’s why it’s essential to use the measure as just one parameter in your overall stock analysis.
One important factor to keep in mind when investing in low-beta stocks is that while they can help reduce the impact of big market moves on your portfolio, that cuts both ways. In other words, you should expect them to outperform the market in a correction but then underperform when the correction ends and stocks start moving higher again.
In a strong bull market, low-beta stocks are best avoided, but if you need a break from volatility, they can help add some ballast to your portfolio.
