The volatility you see in the stock market is historic. On a percentage basis, investors are seeing huge daily swings in the price of stocks and stock indexes. Watching is volatility can be unnerving. If you know one important statistic, however, you can assess the volatility of your mutual fund investments.
The recent decline
The Standard and Poor’s (S and P) 500 is an index of 500 of the largest stocks that trade on exchanges. If you want to assess the recent performance of the overall stock market, the S&P 500 is a good place to start.
The S&P 500 index has declined about 10% since early May. Not the end of the world, but a meaningful decline. The problem isn’t necessarily the percentage decline over time- it’s the roller coaster ride along the way. This roller coaster effect is what really gets to investors.
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How much volatility going forward?
The VIX is the ticket (stock) symbol for the CBOE Volatility Index. The index was created by the Chicago Board Options Exchange, or CBOE. All of the S&P Stocks have options that trade on each stock. An option gives you the right to buy or sell the stock at a specific price. Options allow you to speculate on the price change in a particular stock.
Just as stock prices change, the price on stock options change. Keep in mind that an option’s price is based partly on the market’s expectation of the volatility in the stock. If a stock is expected to be volatile, the option is more likely to generate a profit. Option traders need volatility to profit- either a stock price increase or decrease.
The VIX is a measure of expected market risk in the future- an “investor fear gauge”. From mid-August to mid- September of ’15, the VIX’s value has fluctuated widely.
So, let’s agree that there’s been a lot of volatility in the markets lately. What does it mean to you and the mutual funds you own?
An important measure of volatility for an investment- including mutual funds- is Beta. For an individual stock, beta is a measure of the stock volatility in relation to the market. Here are some examples:
- If your IBM stock price moves more than the overall market (up or down), the stock has a beta of more than 1. If, for example, the S&P 500 increases 10%, your stock price might increases 14%. The same is true on the downside.
- If you Microsoft stock price moves less of the overall market, it has a beta of less than 1. If, for example, the S&P 500 increases 10%, your stock price may increase 7%.
- If you Google stock moves right along with the overall market, the beta of your stock is 1.
You can use this knowledge when you select investments. It’s all about higher risk, higher potential reward. If you’re not comfortable with a lot of risk and volatility, you would look for stocks (or mutual funds) with a beta of less than 1. Sky drivers and people who ride motorcycles without helmets would want a beta of more than 1.
Finding beta for your mutual fund
The easiest way to find out the beta for your mutual fund is to Google the fund and click on their website. I did this for Washington Mutual Investor’s fund. This is a fund that invests in large stocks- all company names you would know.
I clicked on the “Ratings and Risk” drop down menu. Washington Mutual has a beta of .9. So, if the overall markets move up or down 10%, this fund moves 9%.
Low beta funds: Examples
So, you may ask yourself: What is a good example of a low beta mutual fund? This article lists several funds with low betas. One is a portfolio of utility stocks. That makes sense: The earnings of utility companies are steady and predictable. Utility stock prices don’t have as much volatility.
Another fund listed invests in real estate investment trusts (REITS). Given the real estate focus, not as much beta. REITS buy and manage property- less of a connection with the equity markets.
Use your knowledge of beta to select mutual funds with volatility that you can live with. Checking the beta on your fund can give you some peace of mind.
Have you looked at beta? I’d love to hear from you.
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