As you'll recall from our earlier lesson on risk, beta tells you how much you can expect a fund's returns to move up or down given a gain or loss of its benchmark. For example, if the ABC Fund has a beta of 1.1 in comparison with the S&P 500 and the S&P 500 returns 30% for the year, you would expect ABC Fund to return 33%. (30% x 1.1 = 33%.) Since mutual funds don't necessarily produce the returns predicted by their betas, alpha can be helpful to investors.

To calculate a fund's alpha, first subtract the return of the 90-day Treasury bill, for whatever time period you want to measure, from the fund's raw return. What does a government bond have to do with all this? The T-bill serves as a proxy for a risk-free investment and we're assuming that the return of a mutual fund should, at the very least, exceed that of a risk-free investment. This figure gives you the fund's excess return over the risk-free, guaranteed investment. From that, subtract the fund's expected excess return based on its beta. What's left over is the alpha.