To answer this week’s question — does the Modern Portfolio Theory work? — I will explain and feature a chart showing one aspect of its strengths and weaknesses.
First, what is the Modern Portfolio Theory? According to Investopedia.com, it was “(d)eveloped by Harry Markowitz and published under the title ‘Portfolio Selection’ in the 1952 Journal of Finance, MPT says that it is not enough to look at the expected risk and return of one particular stock. By investing in more than one stock, an investor can reap the benefits of diversification — chief among them, a reduction in the riskiness of the portfolio. MPT quantifies the benefits of diversification, also known as not putting all of your eggs in one basket.”
Now, I am all for diversification as long as it is not “diversify and forget.” To explain, let’s examine the six holdings from a reader, purchased in 2012. To date, only three holdings outperformed the Standard & Poor’s 500 while three did not.
Two holdings, DODFX and ODMAX grossly underperformed the market.
The reader held true to the principal of diversification and while being asleep at the wheel, left much needed money on the table.
So, here are action points to think about:
First, these results in no way represent all diversification results.
Second, diversification does not guarantee profitability.
Third, are your holdings diversified?
Fourth, are your holdings outperforming the market returns?
Fifth, if not, why?
In my classes and seminars I teach that diversification works until it doesn’t – and does not guarantee profitability. You can now see why.
Wall Street makes their money with us being in the market. We make our money with what we own and when.
Plan your work, work your plan, share your harvest!