The yield of an investment is tied to the risk associated with the aforementioned investment. The higher the risk is considered to be, the higher the associated yield potential. Except in the most secure investments, such as zero coupon bonds, a yield is not a guarantee. Instead, the listed yield is functionally an estimate of the future performance of the investment. Generally, the risks associated with stocks are considered higher than those associated with bonds. This can lead stocks to have a higher yield potential when compared to many bonds currently on the market.
A benchmark is a standard against which the performance of a security, mutual fund or investment manager can be measured. Generally, broad market and market-segment stock and bond indexes are used for this purpose.
Setting a benchmark can help an investor communicate with their portfolio manager what they're hoping to achieve with their investment, so that the portfolio manager will make decisions with the investor's goals in mind. While a benchmark can help a portfolio manager, it's important that the benchmark being set is right for the investors goals.
An investor's benchmark should reflect the amount of risk he or she is willing to take, the amount to be invested, and the cost the investor is willing to pay. A benchmark should also mirror the investment style of the portfolio. As stated above, mutual funds, international investors, and other investors use different indexes as benchmarks for their investment portfolios because the type of investments they're making are of a different nature. Some portfolios are hard to find benchmarks for, like real estate portfolios, where each investment is different in nature.
Some managers seek simply to meet benchmarks, while others work to beat them. While beating a benchmark can make investors happy, providing too much of an incentive to do so can force a manager to take undue risk with a portfolio.
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the expected return of an asset based on its beta and expected market returns. Beta is also known as the beta coefficient.
Beta is calculated using regression analysis. Beta represents the tendency of a security's returns to respond to swings in the market. A security's beta is calculated by dividing the covariance the security's returns and the benchmark's returns by the variance of the benchmark's returns over a specified period.
A beta of 1 indicates that the security's price moves with the market. A beta of less than 1 means that the security is theoretically less volatile than the market. A beta of greater than 1 indicates that the security's price is theoretically more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market. Conversely, if an ETF's beta is 0.65, it is theoretically 35% less volatile than the market. Therefore, the fund's excess return is expected to underperform the benchmark by 35% in up markets and outperform by 35% during down markets.
