Truth No. 9: When investing, seek ye first Alpha

By Mike Jones, posted August 21st, 2014

Most people think of investing as a personal activity that directly impacts their individual future.  However, most of what we are taught is really only applicable to investors en masse, i.e. the market-at-large, and over large periods of time.  Over the next several months I will share 10 points that I believe every investor should know prior to committing funds to any investment program.

What is Alpha?

"Alpha" is a financial industry measure or calculation that is basically the difference between a mutual fund's expected returns (based on its historical volatility, called Beta) and its actual returns. Alpha takes into account what the market is doing, a client's level of risk aversion, and how an investment manager is doing relative to these factors. Arguably, then, the most important factor in choosing an investment manager is whether or not a manager consistently produces positive Alpha.

Argent Advisors places a great level of emphasis in this investment measurement tool.  We strive to seek out investment managers within the mutual fund world who have demonstrated a capacity for achieving a positive alpha.  Although this process of analysis cannot and does not guarantee any future positive returns, it should be of comfort to our clients that we try to utilize professionals with proven track records.    

The chart below effectively demonstrates this concept.  It displays a popular index of stocks in the United States (the S&P 500, in red) as well as a commonly used mutual fund by Argent Advisors (T Rowe Price Equity Income Fund, in blue).  In both instances dividends are included but no taxes or fees are withheld.  You will notice that the mutual fund outperformed the market by a large margin while taking on approximately the same level of risk.  This difference in performance can be quantified and that is precisely what we refer to as alpha.

Mike Jones is Managing Director / Investing Group of Argent Advisors, Inc. Email him at mjones@argentadvisors.com. Write to him at 500 East Reynolds Drive, Ruston, LA 71270 or call him at (318) 251-5844. The opinions of any single advisor do not necessarily reflect the opinions of Argent Advisors, Inc.  No forecasts can be guaranteed.  Argent Advisors, Inc. does not offer tax, insurance or legal advice.  The information contained in this column should not be construed as a substitute for personalized investment, tax, insurance or legal advice.