Personal Wealth Management / Expert Commentary

Ken Fisher Debunks Beta Measures Risk

Fisher Investments’ founder, Executive Chairman and Co-Chief Investment Officer Ken Fisher discusses the shortcomings of Beta—a common measure of statistical risk in Finance. Specifically, because Beta only uses historical pricing data, Ken says the measure doesn’t effectively assess the current or future risk of a stock or portfolio, which is more important for investors to consider.

Ken also suggests there can be a variety of reasons a stock behaves differently relative to the market over short periods, which affects its Beta. Ken uses an example of an otherwise “stable” stock that might fall more than the market in the later stages of a bear. While the stock’s Beta may rise as a result, Ken says the stock may actually be less risky after the fall than it was before. While Ken understands why Beta was created as part of Modern Portfolio Theory, it ignores the truth that prior price action tells you nothing about future price action.


Ken Fisher:

The presumption as beta was deployed into finance was that if stocks were more volatile in the past, they're riskier. There's actually no part of anything in finance that's ever shown that to be true. Let me take you through that. So in finance and much of the rest of life, you know, there's just a lot of nonsense. Finance has a lot of nonsense in it. That's a very good thing, of course, to also. But one of the things that evolved in the 1950s that's just nonsense is the creation of beta as a finance tool. Originally created by a guy named. Sure. Like, sure. Beta works. And the reality of beta is that it was created. Uh, derive from the mathematical work in the, in the 18th century of Leonard Euler in Switzerland to measure in a fairly complex mathematical way.

The past volatility of something relative to the body that it comes from, in this case, a stock versus the market. And the presumption as beta was deployed into finance was that if stocks were more volatile in the past, they're riskier. There's actually no part of anything in finance that's ever shown that to be true.

Let me take you through that. We have many, many stocks. And in in my book Debunkery, this is debunk number 19 beta measures risk. Every month I do one of these. Beta doesn't measure risk. Beta measures former risk, which actually has nothing to do with future risk. Statistically, it's been demonstrated for a long time that single stock price action. Or price action of the market as a whole does not predict the future. Once you get that, you realize that a stock having been more volatile in the past, does it mean it will be or won't be more volatile in the future? Might be. Might not be.

Let me give you an example. If a stock has been very stable for a long time. And then falls to the floor. Like maybe it's stable, stable, stable, stable, not going up in a bull market much. And then you get into a bear market and early on in the bear market, it doesn't go down much. And then in the back part of the bear market, it goes down a lot more than the market. It's been a while. Is it riskier now than it was before? Well, I don't know. Let's think about that. If it keeps going down. Yeah, maybe if it stops going down.

The drop probably made it less risky. You follow? Let's think that through more fully. Stock goes along. Not going anywhere. Then drops a huge amount, then keeps going along. Was it more risky before the drop? And that's pretty obviously nonsense that it was more risky before the drop. You follow that? Statistically, Beta doesn't tell you anything about the future, but there's a reason it was created. Portfolio theory, as we understand it in modern finance, derives from very specific work done in 1951 that basically explains something called mean variance optimization.

That says that the purpose of a stock or category or new entrant into a portfolio only adds value if it has low future volatility relative to future expected return compared to the portfolio that's entered into by entering the stock into the portfolio, you bring down the total portfolio volatility. Relative future expected return. That's what that says.

So the effect of that as it was evolved, as they need to measure things, they need to find ways to measure volatility and, you know. This was defined as measures of variance and covariance and academics would use beta derived from the Schuler mathematics to create beta, which became very widely accepted. But once you get the notion that prior price action tells you nothing about future price action, you also get the notion that beta only tells you about risk in the past. It doesn't tell you about risk in the present or future.

And so lots of folks still today, particularly those that spend a lot of time studying finance in school and kind of didn't get that lesson that this part of what they teach you in finance in school is just something that's been long accepted as mythology. That's conventional, but it is mythology. It's not actually real. It's theory that doesn't practically translate into real world. There's still people using bait all the time, Ironically, and I challenge you to do this if you go and try to find on Internet, search, Google, whatever the history of beta, it's actually not that easy to find the history of beta.

You can find lots of folks using beta and telling you why beta is good, others telling you why beta is bad like I am. But I'm just going to tell you if you try to make portfolio decisions based on beta and you can get this out of my section 19 on the debunkery and the debunking of beta as a measure of risk. Beta measures risk of the past. It doesn't measure risk for that stock or group of things in the future and using it as if it predicts the future will hurt you. Thank you very much for listening to me. I very much hope you enjoyed this video as part of my series on debunking Common Market Myths. To watch more videos like this, click the link on the screen and make sure to subscribe to Fisher Investments YouTube channel. Thanks so much for listening to me.


A series of disclosures appears on the screen “Investing in Securities involves a risk of loss. Past performance is never a guarantee of future returns. Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations. The foregoing constitutes the general views of Fisher Investments and should not be regarded as personalized investment advice or a reflection of the performance of Fisher Investments or its clients. Nothing herein is intended to be a recommendation or a forecast of market conditions. Rather it is intended to illustrate a point. Current and future markets may differ significantly from those illustrated here. Not all past forecasts were, nor future forecasts may be, as accurate as those predicted herein.”

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