If you're looking for a way to reduce your risk as an investor, low beta stocks might be the answer. Stocks with a low beta are less volatile than the market as a whole, making them a good option for defensive and risk-averse investors.
In this article, we'll explain what low beta stocks are and how they work. We'll also discuss the advantages and disadvantages of investing in them. Finally, we'll ask the question: Are low beta stocks good? And we'll give you our opinion!
What are low beta stocks?
Low beta stocks are less volatile because they are more defensive. This means that they are less likely to be affected by market changes. For example, if the market crashes, low beta stocks will not lose as much value as high beta stocks.
These types of stocks are more commonly found in sectors such as healthcare, consumer staples, and utilities. This is because these sectors are less likely to be affected by economic changes. In times of recession or depression, these products and services are still needed for everyday life which results in a consistent demand and less volatility.
They may not have the same high-growth speculative potential as some other sectors, but they offer stability and reduced risk.
How low beta stocks work
The way low beta stocks work is pretty simple. Beta is simply a measurement of volatility and risk. A beta of less than 1 indicates that it is a low beta stock with defensive attributes. Low beta stocks work in the favor of investors because it is a foundation for one's portfolio since these stocks are traditionally less volatile.
There are also negative beta stocks, which are uncommon and in some cases, can be risky.
With a reasonable weighting to defensive stocks, the panic that often occurs during market corrections can be minimized. Your portfolio will be less susceptible to fluctuations by having a few low beta stocks.
Advantages of low beta stocks
When looking at the advantages of low beta stocks, the clearest one is that they tend to be much less volatile than the market as a whole. This means that when the market is going through a rough patch, low beta stocks are more likely to hold their value, or even increase in value.
This makes them a good choice for investors who are risk-averse, or who are looking to build a defensive portfolio.
Another advantage of low beta stocks is that they often provide a steadier stream of dividends than high beta stocks. This can be attractive to income investors, who are looking for a stock that will provide them with a reliable source of income.
Low beta stocks are more often blue chips than high beta stocks, which can add to their appeal.
Finally, low beta stocks tend to be less affected by changes in the market than high beta stocks. This means that they can be a good choice for investors who are more passive and prefer to take a long-term, slow and steady approach to wealth building.
Disadvantages of low beta stocks
Boredom can be a deterrence for risk-prone investors. Since low beta stocks don't see the high peaks and valleys that higher beta stocks do, some investors may find them boring to hold.
This can lead to disinterest in the stock market entirely and cause more discretionary spending on fun investments like small-cap stocks.
Another disadvantage of low beta stocks is that they can underperform in bull markets. This is when the market is doing well and most stocks are going up in value.
Low beta stocks tend to lag behind the market during these times, which can be frustrating for some individuals. With excitement and greed in the market, offensive stocks take the attention away from the more boring, but defensive low beta stocks.
The final disadvantage we'll discuss today is that low beta stocks may not offer the same upside potential as high beta stocks. This is because they tend to be more established companies with less room for growth like cash cow stocks.
They may not have the same speculative appeal as a small-cap stock or a penny stock. This might not be an attractive ROI potential for some investors.
Are low beta stocks good?
Yes, they are good but it depends on the economic environment. In bear markets, they act as a buffer against volatility. When it comes to bull markets, they can be accepted as a form of insurance or hedge in case a sudden market crash was to take place.
So, although they may not have the same growth potential as other stocks, they perform well when it comes to a defense strategy.
Are low beta stocks safer?
Yes, low beta stocks are seen as safer because they are not as volatile as high beta stocks. As mentioned earlier, they are defensive stocks that partake in markets that are in demand no matter what the conditions are.
However, just because they are seen as less risky does not mean they don’t come with some risks that investors should be aware of. Even if a company's shares are low beta, they are not invincible. When investing, there's always the possibility of a black swan, an unexpected event that could result in a loss.
When do low beta stocks outperform?
Low beta stocks outperform in bear markets. Bear markets are when the stock market falls by 20% or more. Low beta stocks are less risky than the stock market as a whole, so they tend to do better as investors pour into companies that produce a good or service that people need no matter the economic conditions.
When do low beta stocks underperform?
As a reminder, bull markets are when you can expect low beta stocks to underperform. This is because there are fewer incentives for people to be defensive when the stock market is doing well.
When people see others making a lot of money in high beta stocks because the economy is doing well, it can be difficult for investors to hold onto their low beta positions. They may feel like they're missing out and eventually sell their low beta holdings to buy into the hype of a bull market.
Of course, everyone is different and past performance does not dictate future results, but this is a general trend that investors should be aware of.
Simply put, low beta stocks are lower volatility stocks. Many people view them as safer and have fewer risks. However, fewer risks do not mean any risks. Sound investment judgment should still apply, even if they are defensive stocks.
As an investor or trader, you can expect them to outperform the market in times of market turmoil (bear markets) and outperform the market in times of market abundance (bull markets).
They can be a strategic weighting in a portfolio full of high beta stocks, especially for the risk-averse emotionally driven investor.