Can “Modern Portfolio Theory” increase your investment returns?
Recently, on The Goldstein on Gelt Show, I spoke with the inventor of Modern Portfolio Theory, Nobel Prize in Economics winner, Dr. Harry Markowitz.
Dr. Markowitz explained various aspects of Modern Portfolio Theory and its impact on the individual investor. His theory explains how to construct an investment portfolio by optimizing expected returns based on the level of market risk. The goal is to help investors construct portfolios to maximize returns while limiting risk as much as possible. By combining various asset classes in one portfolio, Markowitz explains, the overall account may have a lower volatility and higher return than a portfolio that isn’t properly optimized.
Can theories really help investors?
When investors are faced with market upheaval, they often panic and lose confidence. When I asked Dr. Markowitz how to advise clients during turbulent markets, he spoke about the common mistakes that individual investors make:
“The chief error that the small investor makes is buying when the market has gone up and he assumes it’s going to go up further, and then he sells when the market has gone down and he thinks it’s going to go down more.”
He contrasted this investing model to using Modern Portfolio Theory to rebalance your portfolio to reflect market conditions. If used in the right way, MPT can be effective in turbulent times. When I speak with clients about their U.S. brokerage accounts or their investments in the Individual Retirement Accounts (IRAs), I realize that it’s difficult for them to look objectively at their own money. We all have our emotions tied up in our net worth. But when money managers use MPT to design a portfolio, it can help remove some of the emotional bias that might wrongly influence the way people invest.
To find out more about Modern Portfolio Theory, listen to our 28-minute discussion here.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published September 13, 2016.