What is α Alpha?
Alpha (α) in investing is a risk-adjusted measure that shows how much an investment outperforms or underperforms its benchmark after accounting for the risk taken, helping investors determine if higher returns are truly due to skillful management rather than just taking on more risk.
Alpha is calculated using the CAPM formula:
α = R − Rf - β(Rm - Rf)
α is Alpha (hopefully this ends up greater than zero)
R is your Return
Rf is the Risk Free Rate which is currently this.
Rm is the Market Return of the Benchmark (usually the S&P500)
A positive alpha means the investment earned more than what would be expected for its level of risk, while a negative alpha means it earned less, making alpha a key tool for evaluating whether a manager or strategy is delivering returns that justify the risks taken.
By focusing on risk-adjusted performance, alpha helps investors avoid being misled by high returns that simply result from taking excessive risks, ensuring a more accurate assessment of true investment skill.