Beta is Risk

Yes, you read the headline correctly. The academics got it right. Sort of…

Public market investing rewards those who can identify assets trading at discounts to what they will be worth in the future. But what about the time in between initial purchase and the future? That’s where Beta comes in.

Beta, for those that don’t know, is the measure of a stock’s movement compared to the market. So, if a stock has a Beta of 1.25 a stock holder should expect to see 1.25x the volatility (good or bad) of the market. That volatility can cause some pretty costly errors.

Many, if not most, people have the capability to pick businesses that make sensible investments. Many, if not most, people have the ability to decide a sensible price to pay for an asset. Few people, however, have the ability to consistently see how assets are trading and remain rational. Moreover, the faster the prices move, the less rational people are. Why?

Upside volatility in stocks people don’t own causes FOMO (fear of missing out). This can lead to investors chasing stocks that run at exactly the wrong time. Downside volatility in stocks people own cases the flight response nature ingrained in our psyches. This can lead to people bailing on stocks they own at exactly the wrong time. Joel Greenblatt summarized public investing well when he said he gets paid more to have a strong stomach than for his analytical ability. See http://cfany.gallery.video/fullconference/detail/video/6053271135001/joel-greenblatt—keynote-presentation:-ben-graham-vi at 17:20 and 21:00ish.

So yes, Beta is risk. To the investor’s behavior. Beta, however, is not investment risk. Nor is it business risk. Thus, the academics got it right. Sort of…

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