The Investment Formula Every Investor Should Know: Alpha, Beta, Costs & Risk

So what is alpha? Alpha is the term we describe as extra returns.

So what does it mean? It's basically above and beyond what the market delivers to you.

So we say when we are investing, we're investing into the stock market, the bond market, the real estate market, and so on and so forth.

And as an investor, when you participate in this market, there is this market average returns you can expect to get.

And that's beta.

We'll talk about beta later.

But oftentimes, the investor will want to get extra returns above and beyond what the market gave it to you.

So for example, let me give you an example to illustrate that.

For example, if I were going to invest in a Singapore exchange listed stock, and the Singapore exchange exchange all the stocks in the exchange form that what we would call the singapore stock market and then that had produced a average return often represent the singapore stock market to some degree the singapore overall economy and so on and so forth now if i the stock i buy performed better than the Singapore Stock Exchange overall, then I would have a positive alpha.

And if the stock I bought performed worse than the Singapore Stock Exchange, then it had negative alpha.

Now, all of us obviously want to have better extra returns, so a lot of effort is poured in to find the better stock to perform than the overall market.

However, I must point it out because stock market is based on a buy and sell.

So, for example, I like this stock.

Let's say I like Singtel.

I really like Singtel.

I think Singtel will give me a lot more return.

than the stock market average, I buy Singtel, but someone else will have to sell it.

Otherwise there's no transaction, there's no buy.

So that means that if I bought Singtel, Singtel went up, I got extra return, someone else sold Singtel actually lost that extra return.

So you can see it's actually a zero sum game.

If I win, someone else has to lose.

Someone else win, I gotta lose.

So this alpha is at the very primitive form is a zero-sum game.

Now, often there's cost.

So if I buy and sell a stock, there is transaction fee, there is a bid-ask spread, And once you incorporate these costs and fees, it's actually a negative sum game, meaning that not only I have to beat my counterpart, meaning that I have to figure out whether I want to buy or sell, and win that extra return, but also I have to overcome the higher cost.