Dave Sather's Money Matters: It's all Greek to me
By Dave Sather
I received a call from a former student the other day. John was a superstar at Texas Lutheran, and after several years working in the investment world, he decided to go to graduate school.
As the semester began, John started in familiar territory - an investment class. Unfortunately, John struggled with some of the concepts as they sounded good in theory, but he failed to understand their benefit in practice.
The curriculum required John to calculate things like "Beta" and "Alpha." These Greek letters were devised in academic laboratories to define and measure things like risk and performance relative to risk incurred, respectively.
John quizzed the professor as to how the beta calculation functionally measured risk. The professor said beta measures the movement of one asset, like Pepsi stock, relative to an index, like the S&P 500.
John quickly countered that beta only measured the price volatility of an asset but not the all-encompassing risk of an investment. He proceeded to explain that a thorough analysis of risk should include a variety of fundamental assessments like liquidity, credit, currency, interest rates, debt, inflation and cash flow.
As John got even more energized, he questioned the validity of alpha. John rationalized that if beta were an incomplete measurement of risk, then alpha would also be incorrect because it used beta in its formula.
John then made a deeper observation. He said that alpha and beta may be concepts used by short-term traders, but how would they apply if there were no stock or bond market?
The professor was perplexed by the question.
John elaborated, stating that if there was no stock market for short-term trading, then measurements like alpha and beta would be meaningless. However, it did not mean investing in businesses should be avoided.
John persisted and said to his professor, "If there was no stock market, but you still had the opportunity to own part of H-E-B, Academy, Blue Bell Creameries, Coca-Cola, Budweiser or a host of other great companies, would you?"
The professor admitted that yes, he would.
John said, "Great. Now, since there is no stock or bond market, but you own slivers of great worldwide businesses - how do you measure success? Do you still think that alpha and beta matter?"
John's professor finally conceded the flaws in concepts like alpha and beta.
However, professors and financial professionals often use unique and complex verbiage and terminology. Often, this is done to speak over and around clients. Furthermore, this type of discussion fails to capture things that matter to the average investor.
Recognizing this, don't confuse trading strategies with investing strategies. Success will come by investing for the long term. Short-term trading strategies may sound good in an academic lab, but there is a huge difference between the classroom and reality.
Additionally, invest as if there is no stock market. This will force you to make better-informed, long-term decisions, and you will not be so concerned with the day-to-day blips of the markets.
Finally, the next time someone starts speaking in Greek or anything else you don't understand, ask them to speak in terms that a sixth-grader could understand. There is no shame in saying "I don't understand."
If the person still cannot clearly convey the concepts and their impact upon your portfolio, then maybe they don't understand the concepts properly themselves. If that is the case, maybe you should find someone else to give you advice.
Dave Sather is a Victoria certified financial planner and owner of Sather Financial Group. His column, Money Matters, publishes every other week.