Beta as a Measure of Risk

Course: Investment Planning
Lesson 1: Key Principles of Investing

Student Question:

Hi Dan-

I don’t understand why this statement is true: “Beta is a measure of systematic, non-diversifiable risk.”

I thought Beta was a measure ofrelative volatility?

This is from a Board-Related Question in “Measures of Investment Risk” in “Principles of Investing”.

HI Craig,

Good question and a key concept to know for the CFP Board Exam.

Beta measures the volatility of my security or portfolio compared to the “market.”
Beta answers the question, “How volatile is my portfolio vs. the market?”

The “market” in this case is an appropriate benchmark.

For example, if my portfolio is comprised solely of large cap securities, then the “market” for the beta calculation would likely be the S&P 500 index.

Beta measures ONLY Systematic risk.

Systematic risk includes only inflation risk, reinvestment rate risk, interest rate, market risk, and exchange rate risk.
According to the theories tested on the CFP Board Exam, you cannot diversify out of systematic risk.
- Systematic risk cannot be diversified away.

Beta measures only systematic risk because Beta ignores all other investment risks (nonsystematic risks).

Let me know how fully this addresses your question.