Debunkery: Learn It, Do It, and Profit From It—Seeing Through Wall Street's Money-Killing Myths

BUNK 19

BETA MEASURES RISK

Stocks are risky. Simple fact! But to get return, you must take risk—which many folks feel as volatility. (See Bunk 6.) Volatility is uncomfortable near term for most folks and quite unpredictable—and makes investing even harder than it might be otherwise. Makes many go mental—drives ’em nuts, pure and simple.

Because people are prone to like order, we like to measure. Take beta, for example—the academic concept, widely accepted throughout media and the investing culture, that claims to measure investment risk. Take it outside and leave it there. It’s useless. No—less than useless.

Folks (particularly academics who first foisted beta on us) like to think beta measures risk. No—it measures prior risk. It measured risk—past tense! It doesn’t measure anything about the present or future. Beta itself is a simple and accurate calculation. A stock’s beta is a number representing its past volatility relative to the overall market’s past, over a specific period. The higher a stock’s past volatility, the higher its beta. If a stock moved perfectly in line with the overall market (usually in calculating beta, folks use the S&P 500 as the market index—but beta can be calculated against any market index), its beta is 1.0. Lower, and it was less volatile than the market; higher, and more so. Simple enough.

Past Performance Is Never Indicative of Future Results

Academics first presumed, contrary to centuries of common sense and without any sound reasoning, that ...