Standard Deviation vs. Beta: What’s the Difference in Measuring Stock Risk?
When investing in stocks, risk is a key factor to consider. Two common ways to measure the risk of a stock are standard deviation and beta. While both are useful, they tell you different things.
In this blog, we’ll explain what standard deviation and beta mean, how they’re used, and why it’s important to understand the difference. If you’re a business student or prepping for a finance exam, this guide will make it easy to remember.
What is Standard Deviation in Finance?
Standard deviation measures how much a stock’s return moves up or down over time. It looks at the total volatility of a stock.
A high standard deviation means the stock’s price swings a lot. It could go way up or way down.
A low standard deviation means the stock’s price is more stable.
Standard deviation is a measure of total risk, including both market risk (systematic risk) and company-specific risk, also known as unique risk, diversifiable risk, or idiosyncratic risk.
What is Beta in Finance?
Beta is different. It measures how much a stock moves in relation to the overall market. In other words, beta tells you how sensitive a stock is to market movements. By investing in a stock, you have inherently accepted the risk of the market (systematic risk) and require a higher return over a risk free rate such as a US Treasury. Beta measures how much systematic risk you are taking by investing in this individual stock assuming you are including it in a diversified portfolio.
A beta of 1.0 means the stock should move exactly like the market and you are expecting no more or no less risk than the market.
A beta greater than 1.0 means the stock is generally more volatile than the market and thus you should expect a higher return than the market’s expected return given you are taking on more risk.
A beta less than 1.0 means the stock is generally less volatile than the market and thus you should expect a lower return than the expected market return because you are taking on less risk.
A negative beta means the stock moves in the opposite direction of the market (this is rare).
Beta is a measure of systematic risk, which is the part of risk you cannot diversify away.
Which Risk Measure Should You Use?
It depends on what you’re trying to understand.
Use standard deviation when you want to know how risky a stock is on its own.
Use beta when you want to know how a stock will affect the risk of a diversified portfolio.
If you’re building a portfolio and want to manage how it reacts to the market, beta is more useful. But if you’re analyzing a single stock, standard deviation helps you see how much its price might bounce around.
Why Business Students Should Understand the Measures of Risk
Most finance courses require you to understand both terms. You’ll often see both in CAPM (Capital Asset Pricing Model), portfolio theory, and risk-return discussions.
Also, if you’re planning to work in investment banking, asset management, or financial consulting, knowing the difference between standard deviation and beta helps you communicate clearly about risk with clients and colleagues.
Final Thoughts
Both standard deviation and beta are important tools for measuring stock risk. But they answer different questions:
Standard deviation: What is the total expected volatility of this stock? How much does this stock move up and down?
Beta: How much should this stock move relative to the market?
If you want to dive deeper into these concepts, such as how to estimate standard deviation and beta for a given stock and what the results mean, visit iTutorFinance.com. We specialize in tutoring college and MBA students in corporate finance, investments, and valuation.