Modern Portfolio Theory (MPT) is a fancy term for developing an asset allocation strategy that combines different asset classes with low correlations with each other into an optimized combination of risk versus return. Since it was developed by Markowitz in 1952, some would say hardly "modern".
But it is modern and it does work. That is, over long time periods of regular and irregular distributions of investment returns and correlations it works. However, as Brian Dightman writes in the February 2010 issue of Financial Advisor magazine "...it fails miserably to model the frequency of extreme events over shorter time frames..."
So, be careful when you hear about new theories and strategies to manage your money. Over the long-term, asset allocation and diversification works. New theories abound these days but are mostly new market-timing strategies of one sort or another over short-term time frames.
Here are some that Mr. Dightman cites:
PMPT - Post-Modern Portfolio Theory (tries to identify that losses are worse than gains)
DPO - Dynamic Portfolio Theory (dynamic is just another word for market-timing)
GARCH - Generalized Auto-Regressive Conditional Heteroskedasticity (with univariate, bivariate and multi-variate steps in the optimization process)
Over the short-term, when markets plunge, all assets seem to go down together so the efforts made to have different assets with different correlations does not seem to work very well. But, keep in mind, that this is over a short period (meaning months to maybe 2-3 years).
Can individual investors really benefit from these so-called "sophisticated" strategies?
An Introduction
Hi. Welcome to BourGroup and my blog. Phil
Phil Bour is a CERTIFIED FINANCIAL PLANNER(tm) professional since 2004, a Magna Cum Laude college graduate and an accounting professional for over 35+ years. I love numbers, statistics and economic history.
I am also an Enrolled Agent (EA) to represent taxpayers before the Internal Revenue Service and to prepare tax returns.
"Phil"osophy: I believe that you can manage your money on your own (not necessarily through individual stock selection but through mutual funds, ETF's and other solutions) once you receive some one-time, professional guidance. Why pay annual fees when there may be little added value? For additional information, first read the "An Introduction" label at the left. Then move on to others.
Phil Bour is a CERTIFIED FINANCIAL PLANNER(tm) professional since 2004, a Magna Cum Laude college graduate and an accounting professional for over 35+ years. I love numbers, statistics and economic history.
I am also an Enrolled Agent (EA) to represent taxpayers before the Internal Revenue Service and to prepare tax returns.
"Phil"osophy: I believe that you can manage your money on your own (not necessarily through individual stock selection but through mutual funds, ETF's and other solutions) once you receive some one-time, professional guidance. Why pay annual fees when there may be little added value? For additional information, first read the "An Introduction" label at the left. Then move on to others.