With the market gyrating all over the place, it is time to think about risk. If the market goes into a large decline, how will your retirement savings hold up?
There are a lot of technical ways to measure risk. I won’t even attempt to bore you with the technical aspects of risk measurement. However, there is one risk measurement that ANYONE can use and it is easy to understand.
It is the concept of Beta. Now before you give up on me and go do something else, give this information a try. This is super easy to understand.
This is a very global explanation.
If the stock market goes down 40% and your mutual fund goes down 40%, then your mutual fund is taking 100% of the risk of the stock market. If that is the case, then your mutual fund has a beta of 1. If the stock market goes down 40%, and your mutual fund goes down 20%, then your mutual fund probably has a beta of less than 1. If the stock market goes down 40% and your mutual fund goes down more than 40%, then the Beta of your fund is probably greater than 1%.
A Beta of 1= same risk as the stock market
A Beta of less than 1 – less risk than the stock market
A Beta of more than 1 – More risk than the stock market
(See disclaimer at the end)
So, if you want to take risk, you might consider lower Beta funds.
Let me give you an actual example of a higher Beta fund versus a lower Beta fund. I want give the name of the funds. However, I will show you the results.
Fund A has a Beta of 1. It is taking the identical risk of the stock market. Fund B has a Beta of .69. It is taking less risk than the S&P 500. Look at Fund A versus Fund B during the financial crisis.
Fund A Fund B
End of 2007 $100,000 $100,000
End of 2008 62,980 83,400
End of 2009 79,663 102,190
End of 2010 91,540 113,727
End of 2011 93,343 116,490
As you can see fund B which took less risk, made up the losses by the end of 2009 while it took Fund A until 2012 to be back above 100,000. Now this relationship of fund performance to Beta isn’t guaranteed to work this way every time. However, I think that is a good way to manage risk.
How do you find the Beta for a particular fund? You can look at www.morningstar.com. However, they don’t publish the Beta for every fund. Your best bet is to call the fund company directly to get that information.
If you have a particular question about a fund, you are more than welcome to send it to firstname.lastname@example.org. Also, to find out about your Prudent Money DNA and determine your risk level, take the free risk assessment and I will send you back an analysis. Click Here for more information
DISCLAIMER – This is in no way an attempt to give advice on fund selection. This is simply an introduction to a risk measuring concept. Published Beta’s for mutual funds are not guaranteed to be accurate.