Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific investment advice. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “Our investment advice on how to interpret ‘beta’ ratings”

Beta ratings are a measure of stock-market volatility. Stocks with a beta of 1.0 have exactly the same degree of volatility as the market they trade in, based on a comparison of fluctuations in the stock and the market index over a period of time, usually five years.

If a stock’s beta is below 1.0, the stock is less volatile than the market. High-beta stocks above 1.0 are generally more volatile than the market. (If a stock has a negative beta, it has an inverse relationship with the market; it tends to fall when the market goes up, and vice versa.)

Our 3-part investment advice helps you naturally diversify into high- and low-beta stocks

In a rising market, high-beta stocks tend to jump ahead of the market indexes. However, when the market declines sharply, high-beta stocks can fall more quickly than the market, and be slower to recover. Low-beta stocks may not move up as quickly as the market indexes, but they’re unlikely to fall as far during market declines.

In managing the portfolios of clients of our Successful Investor Wealth Management service, we employ our long-standing 3-part investment advice: invest mainly in well-established, dividend-paying companies; spread your stock market investments across the five main economic sectors (Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities); and avoid stocks in the broker/media limelight.

By following this investment advice, we naturally diversify into high- and low-beta stocks. That adds potential for strong gains when the market is rising, but also adds stability that helps protect your portfolio in market declines.

Invest in your Financial Future for FREE Learn everything you need to know in '9 Secrets of Successful Wealth Management' for FREE from The Successful Investor. Secrets of Successful Wealth Management: 9 steps to the life you've always wanted, before and after retirement.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

That’s in contrast to advisors and portfolio managers who take on a lot of risk by loading up on high-beta stocks. These managers can show bursts of high performance when the market is rising. However, when the market declines sharply, these portfolio managers can lose far more than the market, and be far slower to recover — if they recover at all.

Investment advice: Well-established companies are the key to consistent, lower-risk returns

It’s hard if not impossible to predict when the market will jump. It’s even harder to predict when a rising market will reverse course and plunge. This simple fact of investment life causes an extraordinary amount of loss and investor bewilderment. That’s because it’s too easy to give yourself credit for a gain you owe to buying a high-beta stock when the market is rising, or just before the market takes off.

If you mistakenly give yourself credit for a gain like this, you may then go on to fill your portfolio with more of the same kind of stock. That can keep on paying off for a time. But inevitably the market quits soaring and stumbles. When that happens, the worst stocks to hold are the high-beta variety. When the market is falling, they tend to fall even faster.

If stocks like these make up a big part of your portfolio, even a mild market downturn can leave you with horrendous losses.

Our investment advice? Keep beta ratings in perspective. All in all, a stock’s beta rating makes a broad statement about its history of volatility. Unfortunately, it tells you nothing about its inherent safety or future prospects. For that, we look to the key factors we analyze in awarding one of our six TSI Network ratings (Highest Quality, Above Average, Average, Extra Risk, Speculative and Start-up).

We recently published a two-part Investor Toolkit series on our TSI Network ratings, and how you can use them to increase your stock-market profits with less risk. Click here to read Part 1 of this series (you’ll find the link to Part 2 at the bottom of the article).

If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.