We have an issue with investment theories that look great on paper but may not help people build wealth. The vagaries of human nature mean that investments which are appealing and popular and those which make money tend to be two different things.
In our opinion, Modern Portfolio Theory or MPT is in the category of ‘looks great on paper.’ MPT attempts to mitigate risk by diversifying a portfolio across different asset classes with different risk profiles. But it can not predict the future–this risk analysis is based on historical performance trends. Backwards looking, it tends to work until it doesn’t. It does, however, generate nice pie charts and beautiful rationalizations.
The apparent precision of MPT, based on measuring things that have little bearing or relevance to long term investors, may be a key factor in its appeal. We concluded that a lot of effort goes into measuring things that can be measured, whether or not the exercise is useful.
Recently we measured something in your accounts. We think it is telling evidence of our work together, your effective investing behavior and our research and portfolio management.
You can see in LPL AccountView or in reports we can run for you where your account balance stands relative to your cumulative net investment over time. In other words, your deposits and withdrawals since the beginning add and subtract to determine your net investment. By looking at your balance, we can tell the cumulative net gain or loss you have made over the years.
Many advisors could tell you the expected standard deviation of your portfolio, or the proportions of each asset class you should own, down to the hundredths of one percent, based on past performance. Some offer reports that compare monthly, quarterly, and annual account performance against a series of benchmarks.
If we had to guess we would say our simple measurement is the one you care about—did your bucket grow? And by how much? Clients, if you would like to tell us differently, or have a longer discussion on this or any other topic, please email us or call.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
Investing involves risk, including possible loss of principal.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.