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A popular Wendy's commercial in the 80s made famous the question: "Where's the beef?" Good one. And here's an even better one: "Where's the alpha?" You might want to whip this one out the next time you meet with your portfolio manager.
Alpha is the over-and-above-the-expected return. It is the "value added." Therefore, it makes sense that a positive alpha means an investment has outperformed its market-predicted return, while a negative alpha would mean just the opposite. The expected return is calculated by a formula that takes into account the investment's level of unavoidable risk (aka beta).
Ever stepped into an elevator and after the doors close you become aware of an almost-suffocating scent coming from the woman next to you who must have bathed in perfume? Well, as you know, once the doors close you can't escape the smell until the ride is over. This is similar to beta, which is risk that can't be reduced or diversified away. A measure of "systematic" or market related risk, beta is used as a measure relative to a certain index -- such as the S&P 500.
So, for example, let¿s say your portfolio is managed to compete against the S&P 500. If you generate a better return than the index while not taking on added risk (standard deviation of returns) then you get alpha. Low beta means the market-related risk is low and vice versa for high beta.
Another example, let's say a mutual fund or stock has a beta of 1.5 relative to the S&
P500 ¿ that means it is 1.5 times as risky. So, over time, if the S&P 500 goes up 1%, your portfolio should be up 1.5%
plus (one can hope) some percentage of alpha. If the S&P 500 is down 1%, your portfolio should be down 1.5%.
Alpha
and beta are based off of linear regression of a set of data. Warning: this may cause a high school fifth-period flashback,
but it will be over before you know it:
The equation for a line is Y = a + bX.
a = alpha (the Y intercept - the added
value)
b = Beta (the coefficient you multiply X by)
X = S&P 500 (in this case)
Y = your portfolio
Home / Personal Finance / Financial Planning / College & Education
Tuesday, November 27, 2007
Kid Money
Teachers Say Finance Fundamentals Required to Make It in Global Economy
Kathryn Elizabeth Tuggle
FOXBusiness
NEW YORK--In a global economy, teachers contend finance fundamentals are an essential piece of today’s well-rounded education pie.
Since
1977, the “Stock Market Game” has been teaching children how to play the markets. As demand for financial education in public
schools continues to increase, this year more than 600,000 students are busy investing their imaginary $100,000.
“Teachers
have a responsibility to teach the whole economy,” said Ken Reed, an accounting teacher at Blackman High School in Murfreesboro,
Tenn.
Reed has been using the stock market simulator as a part of his curriculum for the past eight years.
“Teaching
the stock market has made my students more competitive in math, and makes them interested in applying it in real life." Reed
said. "I tell them all the time that you don’t have to be a stockbroker when you grow up to need knowledge of the markets.
You can be a nurse and still need to make investments,”
He said that video-game-like tools for finance brings textbooks
to life.
Reed is not alone in thinking kids need to be hands-on when learning about the stock market.
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