In the world of investing, volatility matters. Investors are reminded of this every time there is a downturn in the broader market and individual stocks that are more volatile than others experience enormous swings in price.
Volatility is a proxy for risk; more volatility generally means a riskier portfolio. The volatility of a security or portfolio against a benchmark is called Beta.
Importantly, low or high Beta simply measures the size of the moves a security makes; it does not mean necessarily that the price of the security stays nearly constant.
Indeed, securities can be low Beta and still be caught in long-term downtrends, so this is simply one more tool investors can use when building a portfolio.
However, history would suggest that simply isn’t the case. Indeed, this paper from Harvard Business School suggests that not only do low Beta stocks not underperform the broader market over time – including all market conditions – they actually outperform.
The formula to calculate a security’s Beta is fairly straightforward. The result, expressed as a number, shows the security’s tendency to move with the benchmark.
The numerator is the covariance of the asset in question with the market, while the denominator is the variance of the market. These complicated-sounding variables aren’t actually that difficult to compute – especially in Excel.