alpha
A measure of an investment's performance relative to a benchmark index, representing the excess return generated by the portfolio manager's skill rather than market movement.
Example
“The fund manager generated 4% alpha last year, meaning the fund beat the S&P 500 by 4 percentage points.”
Memory Tip
Alpha is the 'A' of returns — above and beyond what the market gives you.
Why It Matters
Alpha helps you evaluate whether your investment manager or strategy is actually earning you better returns than you could get by simply buying an index fund. Understanding alpha is crucial for deciding if the higher fees you pay for active management are justified by superior performance that beats the market.
Common Misconception
Many people believe that alpha means any positive return on an investment, but alpha specifically measures returns above what the benchmark index would have generated during the same period. You could have a positive return but negative alpha if the market went up even more than your portfolio did.
In Practice
If the S and P 500 index returned 10 percent in a year and your managed portfolio returned 12 percent, you might think you did great, but your alpha depends on the risk taken. If your portfolio had similar risk to the index, your alpha would be about 2 percent, suggesting the manager added real value through skill.
Etymology
From Greek 'alpha', the first letter of the alphabet, used in finance to denote the first source of return beyond market beta.
Common Misspellings
Start investing with no commission trades
Related Terms
More in investing
Other investing terms you should know
See Also
Need financial definitions?
Clear definitions for 2,500+ finance, insurance, and investing terms.