Tag Archives: retirement investing

What is beta?

Before the Netflix era made watching rare high-quality films as simple as turning on a light switch, the height of late 1970s technology for the hi-fi home entertainment viewing experience looked like this:

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When I was young, my father believed that beta videos offered the highest quality means of watching his favorite movies. Technically, he was correct. Betamax videos maintained their integrity for sharing purposes much better than their VHS counterparts. Our family collection included Dune and, of course, all of the Star Wars and Indiana Jones movies. We didn’t need HBO. My dad just copied the movies he liked using a second player. It was a great system.

Somehow, we continued in this fashion deep into the 1980s, when the proprietor of the video store we frequented finally sold off his Betamax video collection. One by one, our “higher quality” home movie theater became more and more obsolete.

I think my dad was the only guy who rented the things from him. Somehow our family still managed to find films to watch. Even as the selection shrunk until it was just a few rows of faded video boxes in the way-back dusty corner of a video shop in a forgotten strip mall.

Thus, for me personally, the word beta is suffused with memories of light sabers, fear of snakes, eating monkey brains, and driving way too far just to rent bad movies.

Other people associate the word beta with their college experience. The college fraternities and sororities of the US are frequently referred to as collections of letters from the ancient Greek alphabet. Beta Theta Pi. Phi Beta Sigma. Alpha Phi Beta. Sigma Beta. Sigma Phi Beta. Beta may be the most widely used letter in this “Greek” system. That must be because it’s easy for folks in the modern Greek life to remember. It looks like a B:

Where else is beta? Everywhere. Beta represents vital concepts in many fields: computing, finance, phonetics, mathematics, rock climbing, and statistics.

Software first gets released in beta so that the developers can discover bugs and inconsistencies that they otherwise could not have found on their own. Gmail was a beta product for five years before Google felt comfortable removing the moniker.

Much in the same way that the symbol for beta is often mistaken for the Roman letter B, concepts represented by beta are often those that we cannot possibly know but absolutely must discern.

In finance, the concept of beta has just this characteristic. Beta is a widely used (as well as widely misunderstood) measure of market risk. It provides the slope of the risk-return tradeoff line for a portfolio as defined by the capital asset pricing model formula.

If you’re looking for the beta of a particular stock, it is provided in all statistical packages and nearly all statistical websites. Let’s take a look at this screenshot from Yahoo! Finance:

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Beta is right there circled in red.

In order to interpret this particular stat, you should think that Apple (AAPL) stock in the most recent 36 monthly periods (3 years) has performed as well as the market has plus another 35 percent.

Note:  I do not mean 35 points, I mean percent. So if the market goes up 2% in a month, AAPL should go up 2.7% not 37%. By the same token, if the market goes down 2% in a month, AAPL will go down 2.7% as well.

A stock with a beta of below 1 will have much better monthly returns, on average, in times of market deterioration. In fact, some scholars believe that, in the long run, persistently sub-one betas may also enjoy excess returns.

So “BET AGAINST BETA” and amass low beta investments.

Do it for long enough and you might just become one of the 18% of active fund managers that beat the market over a decade’s time.

Beta is often mistakenly thought of similarly to the correlation of a particular stock to the stock market as a whole. And if we think of the market as an example of the “perfect” amount of risk that a “rational” investor should be willing to take on at any “normal” point in an investing lifetime, then beta can be described as a sort of risk measure. That is, at least, the story from the perspective of contemporary financial theory.

But, technically, beta is not a direct measurement of risk. It can only tell you if a collection of assets has more or less risk relative to a benchmark. And when the benchmark itself swings about wildly as indeed all market benchmarks have recently been doing, it can seem like supposedly low-risk stocks are just as high-risk as any other high-risk venture like a Tesla (TSLA), Chipotle (CMG) or Shake Shack (SHAK).

This risk of rapid price swings that seems to be inherent in all modern financial markets is known as systematic risk. It is said that we cannot diversify this risk away. No matter what magic tricks we deploy to construct a portfolio.

Basically, beta is a comparison of the variability of one single investment with the variability of a chosen market. Because it is comparing a second-order effect, i.e. variability, rather than a statistic more directly linked to company performance, like price level, we cannot accurately state that it is a direct measure of risk. It is most precisely a measure of relative variability that hints at the possibility of risk.

However, beta is an important part of the toolkit a portfolio manager employs to create personalized investment portfolios. Paying close attention to beta levels at the portfolio level maximizes return levels. It puts a reasonable floor underneath your potential losses and significantly diminishes the scope and scale of a portfolio’s risk levels. While a rational investor cannot ever escape their exposure to systematic risk, they can reduce the impact that that risk has on portfolio returns.

And for this reason alone, investors must get to know beta.

Beta is a critically important statistical factor in investment consideration.

But the best reason to prioritize beta analysis in selecting investments is that it is widely available data. For the most part, you don’t even have to calculate it. It is easy to find and, as long as you know exactly what the beta number you are looking at actually means, it is also easy to use to create a portfolio that has lower risk than the stock market as a whole.

And isn’t that what investing is all about? To invest with lower risk?

We all have to invest. It is how we transport the money we hope not to spend today into a future that may include more certain and costly financial demands.

Emphasizing low beta assets allows us to do this time travel with substantially lower risk.

What is “finance”?

Define. Confine. Finite. Finish.


The word finance shares its root, the Latin word finis meaning “boundary” or  “end,” with many other terminal words. In fact, the mere mention of the word “finance” to many people causes an abrupt end to conversations. As much as we like to harp on the old maxim that “money isn’t everything,” we often must grapple with the constraints its lack of bountifulness in our lives places on our mind, body, and spirit.

Or, as one of the great poets of our time, Kanye West, once said:

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“Having money isn’t everything, not having it is.”

Etymologists and linguists would have to agree. Limitations are literally in finance’s DNA.

In modern English, finance was first used as a noun in 1739. The noun denotes all the various ways people manage money: as individuals, as businesses, and as institutions. The formal terms for these divisions are personal finance, corporate finance, and public finance.

Finance was first used as a verb in 1866 to describe the method of obtaining other people’s money to pay for items forthwith, creating simultaneously future obligations to repay the sums obtained, plus interest.

As America recovered from its disastrous Civil War, the concept of borrowing now to pay back later became a necessary part of Reconstruction.

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America’s Civil War debt took almost 35 years to get under control, and by the time it was… along came another war.

Reconstruction, in fact the Civil War itself, was financed. The World Wars, and the Keynesian policies of the Great Depression in between them, were financed. In the post-war boom, American citizens began to finance purchases of homes and cars, beginning an exponential trend that would not relent until the Great Recession.

It was quite a century for the newly fashioned verb.

household-sector-1940-2012The Greatest Generation began to finance their lifestyle in the early 1950s. Household debt gradually increased until its first inflection point after the 1981-82 recession. Its second inflection point came during the dot-com bubble, after which household debt doubled in less than a decade.

100 years after the homonymic development of the verb finance, both governments and individuals were free to finance their finances. Anything you could buy could be financed. And finance professionals helped arrange your finances with finance products that you could finance.

A pyramid scheme? Perhaps. Needless to say, the finance industry has experienced nearly uninterrupted growth since the end of World War 2. Today, approximately 8% of the income earned in the United States comes from the finance industry. Eight percent.

finance income shareAs shown in this chart from a 2011 New York Fed report, the US finance industry, in tandem with the advent of the compound noun “portfolio investment,”  has inexorably grown into a trillion-dollar-plus industry.

Hence, although the finance industry should at least be subconsciously aware of the limitations inherent in the very nature of the word that defines their occupation, they still have yet to find its boundary or end.

If you are not a financial intermediary, the Latin root of the word finance hits a little closer to home. Borrowing today to finance today’s finances is a habit of personal finance that can only last for so long. Eventually, the carousel stops spinning for common folk. We are not Too Big To Fail and there is no Fed discount window for us to borrow from. Currently, qualified institutions can borrow at a 0.15% interest rate. Institutions with literally hundreds of billions of dollars in cash sitting on their balance sheet. Zero point fifteen percent!

Unlike corporate finance, the realm of personal finance is largely unchanged from the 15th century, when the French coined the term mortgage by combining the terms for death and pledge. More than 500 years later, the finance industry nearly destroyed us all with their own “death pledge” wizardry. In return, the US government allows these same institutions to borrow at an absurdly low rate. 0.15%!  Meanwhile, most people do not even qualify for a mortgage. But I digress… this invective is a story for another post.

Although financial study lies at the confluence of economics, accounting, and math, the word finance itself intimates a dual perspective on limits. On the one hand, institutions and corporations use finance to stretch those limits to the utmost. On the other, individuals increasingly finance themselves into financial straitjackets that severely limit their personal freedom.


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