Investors use Greek letters to designate specific things, just as physicists and public health experts do. In this case, alpha signifies a standard of measurement that compares the performance of an investment against its benchmark. The benchmark is frequently an index like the S&P 500.
It’s similar to (but not the same as) beta, the measure for short-term volatility. Unlike beta, which you can find listed on platforms like Robinhood and sites like Yahoo Finance, alpha only really gets talked about in the context of actively managed funds and portfolios. Fund managers are providing value to their investors when they produce a positive alpha.
Alpha is comparable to, but not the same as beta. Beta is a measurement of volatility that lasts only for a short time. Alpha is only mentioned in the context of actively managed funds and portfolios, as opposed to beta, which you may find on platforms like Robinhood and sites like Yahoo Finance. When fund managers achieve a positive alpha, they are giving value to their investors.
Say you're looking at an actively managed mutual fund. Over the past year, the hypothetical fund produced 4.3 percent, whereas the market index posted 6%. The alpha is -1.7.
Anything above zero is ideal, while anything below it indicates an underperformance relative to the benchmark—bad.
It's critical to compare your portfolio against the proper yardstick. Comparing alphas that utilize different standards may distort your investment choices, and investors occasionally pick the incorrect benchmark, rendering the alpha calculation useless.
Some things to consider:
Alpha isn't intended to be used in isolation. It's one of several risk metrics that investors should consider before making a selection.
If you're analyzing alpha, you're probably looking at an actively managed fund. While they have their place, the majority of actively managed funds underperform comparable passively managed funds, implying negative alphas are quite frequent.