Has Modern Portfolio Theory Reached Retirement Age? Financial Advisors' Daily Digest
By SA Gil Weinreich :
Nobel Prize winner Harry Markowitz' famous upward-sloping curve linking the highest expected return for any given level of risk turns 65 this year, and SA contributor Ronald Surz thinks it is time for the academic theory, known as Modern Portfolio Theory ((MPT)), to retire with dignity .
Surz's reasoning is that there are younger, more up-to-date approaches that are working more effectively, such as Dr. Frank Sortino's Post Modern Portfolio Theory (( PMPT )). He nicely illustrates one practical difference between these two approaches:
Post Modern Portfolio Theory…views risk as the possibility of failing to achieve an objective.… For example, if we need to earn 8% to achieve our goals, cash is a high risk asset because we're not going to succeed with cash. By contrast, cash is always low-risk in an MPT world.
I can see a challenge to PMPT. It may be true that the investor is at risk of not achieving his objective with cash, but the different (presumably much more aggressive asset mix) that PMPT would lead to in this scenario risks blowing up the investor's portfolio via negative rather than near-zero returns. Of course, whether this were to happen hinges on the investor's precise goals and timeframes.
I am not here making an argument favoring cash. What I would argue (and I'll leave it to experts like Ron Surz and other commenters to indicate the name of the theory that this goes by) is that there comes a point in time, near retirement, when aggressive portfolio allocations become reckless. However, if one established a stock-heavy portfolio early enough, when retirement was not close, an investor could establish and maintain an aggressive portfolio indefinitely. It all comes down to planning ahead. That said, a reasonable allocation to cash, or short-term bonds, can benefit even aggressive investors by smoothing out the volatility.
Please let us know your thoughts in our comments section. Here are today's advisor-related links:
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
