What Is a Mutual Fund Beta?

Definition and Example of a Mutual Fund Beta

Beta, as it pertains to mutual fund investing, is a measure of a particular fund's sensitivity to movement in the broader market. In other words, it's a measure of volatility.

The beta for the market is exactly 1. If the mutual fund beta is 1.1, this indicates that, when the benchmark index is up, the fund has historically performed 10% better than that index. Conversely, when the benchmark index is down, a mutual fund with a beta of 1.1 can be expected to decline by 10% more than the index.

A fund can also have a beta that is lower than the benchmark index. In that case, if the fund's beta is 0.9, an investor can expect the fund to perform 10% worse than the index in up markets, and 10% better in down markets. For example, if the index gains 10%, the fund would be expected to gain 9%. If the market falls by 10%, the fund would be expected to decline in value by 9%.

How Does a Mutual Fund Beta Work?

As an example, consider a hypothetical fund that tracks the S&P 500 with a beta of 1.1. If the S&P rose by 10% one year, an investor who owned the hypothetical fund would have a return of 11%. If the S&P 500 index fell by 10% during the given year, the fund with a beta of 1.1 would be expected to fall by 11% during that year.

A mutual fund investor can use beta information to better plan their fund selection and match their investments with their investing style. If they're willing to tolerate wide swings in the fund's net asset value (NAV), then they may choose a fund with a high beta. These would be aggressive investors who are seeking high returns and willing to tolerate more volatility.

Investors don't have to go all-in on a mutual fund with either high or low volatility. They may also choose to use a core and satellite investment strategy to diversify around a core holding. The core—where the bulk of their money is invested—represents the risk tolerance they're most comfortable with. Then, they build smaller "satellite" investments with different betas around that core. In this regard, beta can be used to better control volatility as you diversify and build a portfolio of mutual funds.

Alternatives to a Mutual Fund Beta

Beta is a statistical measure that can be quite useful for diversification and advanced risk/volatility measurement purposes. However, the average investor might not find it necessary to use beta in the process of choosing mutual funds. Many mutual fund summaries simplify the risk section—potential investors will often see the risk of a mutual fund listed in simple terms like "aggressive" or "conservative."

The overall risk of a given portfolio is determined by its unique asset allocation—the mix of various types of funds held. While beta can help you control risk exposure, diverse asset allocation is also important. For example, if you use an S&P 500 index fund for a core holding, you will need to choose other funds that are not investing in the same holdings as the index. In this case, since the S&P 500 index consists of large U.S. stocks, the investor could diversify with small-cap stock funds, international funds, and bond funds.