In this blog post, we will delve into an informative and insightful discussion on the topic of risk in the world of investments. Specifically, Fisher Investments’ Founder Ken Fisher shares his expertise and debunks the common misconception that beta measures risk. As a highly respected figure in the investment industry, Fisher’s insights and analysis are sure to shed new light on this important topic. Join us as we explore the intricacies of investment risk and discover why beta may not be the ultimate measure of risk after all.
Introduction:
Ken Fisher, the founder of Fisher Investments, is a renowned figure in the world of finance. He has penned several books and has been a regular contributor to magazines like Forbes and USA Today. In one of his articles, Ken Fisher has shed light on the shortcomings of Beta as a measure of statistical risk in finance. In this discussion, we will delve deep into the topic and understand why Beta is not the most reliable measure of risk.
What is Beta?
Beta is a popular statistical measure that expresses the volatility of a stock or portfolio relative to a benchmark. Typically, the benchmark used is the S&P 500 index. The beta coefficient measures how much a stock or portfolio moves concerning the broader market. A beta of 1 indicates that the stock is as volatile as the market, while a beta less than 1 implies that the stock is less volatile than the market. Similarly, a beta of more than 1 indicates that the stock is more volatile than the market.
The Shortcomings of Beta as a Measure of Risk:
Ken Fisher discusses the shortcomings of Beta as a measure of statistical risk in finance. He argues that Beta only uses historical pricing data, making it ineffective in assessing current or future risk. Beta may give you an idea of how much a stock moves relative to the broader market, but it tells you nothing of how the stock will behave in the future. Factors like a change in management, industry disruption, or government regulations may significantly impact a stock’s value, but Beta doesn’t capture any of them.
Different reasons can affect how a stock behaves relative to the market over short periods, which affects its Beta. For instance, a company that has suffered a one-time blow to its stock price may have a lower Beta than it did before, meaning that it may be less volatile than the broader market. The same company may not be less risky in the long term, but you will never know that from Beta.
Ken Fisher uses an example of how an otherwise stable stock may be less risky after a fall than it was before. He cites an example of a company whose stock price falls from $100 to $50 and then steadily rises to $75. While the stock price was $100, the stock had a Beta of 1. However, when the stock price was $75, its Beta had fallen to 0.5, indicating that it was less volatile than before. Ken Fisher argues that Beta fails to capture the fallacy of composition, which means that something that may hold true for a part may not hold true for the whole.
Beta was created as part of Modern Portfolio Theory, which ignores the truth that prior price action tells you nothing about future price action. Ken Fisher points out that past performance is not a guarantee of future returns. In simple terms, just because a stock was volatile in the past doesn’t guarantee it will be volatile in the future.
Conclusion:
Investing in securities involves a risk of loss, and past performance is never a guarantee of future returns. Therefore, it is critical to understand that Beta is not the most reliable measure of risk. The opinions expressed are subject to change without notice, and nothing herein is intended to be a recommendation. Investors should do their homework and assess all relevant factors before investing in stocks or portfolios. If you’re looking for sound investment advice, always consult an experienced financial professional who can help you make an informed choice.
