Why We View Beta and Stock Market Risk All Wrong

The traditional view of the stock market is that investing is risky, and the higher the beta of stocks in a portfolio, the riskier that portfolio is.

But is that really true, and is beta the best measure of risk for long-term investors?

To find out, we must first understand what beta is.

Beta is a measure of a stock's volatility. Essentially, it indicates how much the price of a particular stock is expected to move in relation to movements in a benchmark market index, such as the S&P 500.

The formula is:

Where: Rs ​ = Return of the stock

Rm ​ = Return of the market

If you’re investing in a handful of high beta stocks, then you’re investing in stocks with higher volatility in share price vs. the market average. But is this really the best way to quantify risk?

To a long-term investor, who is not in need of selling their securities for liquidity over a short time frame, beta may not be a good view of risk.

That is because, as an owner of a given business, the real risk is not short-term price volatility, but rather business underperformance.

Whether a business over or underperforms is not a function of beta. In fact, low beta stocks don’t always stay low beta and have the potential to also be highly volatile.

For instance, the below traditional low beta blue chip stocks are all down significantly YTD (Chart dated May 15, 2025, vs. 2024):

As we see above, it’s not the past beta that determines risk, but rather the underlying business performance. Sooner or later, that is eventually reflected in the share price, like it did for the above blue chips.

Warren Buffett also subscribes to this belief. A telling quote of his on beta is as follows:

So, if our portfolio risk isn’t about beta, how do we evaluate how risky a portfolio is?

Instead of looking at past share price volatility, one should consider the fundamental qualitative factors of a business. Such as:

• Moat strength

• Ongoing product-market fit

• Whether the business is on the right side of future trends

• Management quality and ability to navigate change

For instance: is a business losing new cohorts to competitors? If you’re Target, and new consumers are increasingly choosing Costco instead, you may be on the wrong side of consumer behavior and trends.

In summary, long-term investors not in need of short-term liquidity may benefit from paying less attention to share price volatility and beta and more attention to business fundamentals. That is, after all, a primary predictor of future share prices.

As always, past performance does not dictate future results.

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