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Assuming you believe the underlying assumptions (and they very well may not be true), modern portfolio theory allows you to build a mathematically ideal portfol

by jhulla 12y ago

Assuming you believe the underlying assumptions (and they very well may not be true), modern portfolio theory allows you to build a mathematically ideal portfolio for a given amount of risk. The math behind MPT might be hand waved as followed: goal seek a maximum portfolio return by combining assets with minimal correlation under a fixed risk scenario. In the end, you will have portfolio that will give you the maximum theoretical return for your selected amount of risk. In practice, outside of running a hedge fund, or a mutual fund with explicit investment guidelines (e.g. we invest in emerging market energy companies), a responsible asset manager has no choice but to follow MPT. In other words, if you are not a specialized fund, there is no mathematical justification for deviating from an MPT constructed portfolio. By definition, any deviation from a MPT balanced portfolio means you have either a) taken on more risk than necessary or b) reduced your potential return or c) do not believe in the underlying assumptions of MPT. So what is the amateur person worth $25M to do today? As with all things, you should seek professional advice. There are many nuances of tax efficiency, estate efficiency, asset protection, personal needs, etc. that a professional advisor should guide you through. Apparently the folks at WealthFront and FutureAdvisor are selling MPT driven portfolios to employees of SF bay area tech firms. edit: As a couple of users point out below, there is controversy over the effectiveness of MPT including: whether the models effectively capture the distribution of risk vs return and whether the values desired by the models can be calculated with proper accuracy. PMPT (post-modern portfolio theory) builds upon MPT. Lastly there are critics such as Nassim Taleb (of Black Swan fame) who find some of the core assumptions flawed.

hkmurakami 12y ago
>So what is the amateur person worth $25M to do today? As with all things, you should seek professional advice. There are many nuances of tax efficiency, estate efficiency, asset protection, personal needs, etc. that a professional advisor should guide you through. While this is true, the problem that most advisors that a $25MM net worth individual has access to are mostly duds and/or salesmen. Identifying true value add advisors is easier said than done, imo.
- deleted 12y ago
  [deleted]
- encoderer 12y ago
  Personally, i think that's more of a problem for the guy with the $500k retirement account. You will have no shortage of white gloved managers eager to help you invest your $25M. But anything short of $1MM you're solidly in Edward Jones territory. At that point you're probably better off keeping it stuffed under your mattress. If you're not a multi millionare, IMO it's worth the time to learn how to manage your own money. Because nobody will ever care as much about your money as you will. A good place to start IMO is by subscribing to the TastyTrade podcast. It's the only investing infotainment I've found that treats the listener like an adult and an equal.
  - hkmurakami 12y ago
    IMHO, the quality of people you will find at your local retail branch of an ibank (think BoAML, JPMChase, WF/Wachovia, etc.) is still very shoddy and suspect. These are the channels that people have immediate access to and think of visiting, even if you have $25MM. For these retail operations, iirc the threshold is $50MM before you are shipped off to a proper PWM team at HQ. >You will have no shortage of white gloved managers eager to help you invest your $25M. How do you know which while gloved manager is actually any good though, assuming that the $25MM guy is quite naive about investment management? I believe that the small time millionaire must be up to speed on investing basics just as much as the $500k guy, in order to be able to discern the competence of his managers. I generally agree with jhulla's advice of going through a good estate planning attorney or accountant to find decent people. If you have a network of rich friends (which you can probably make in a few years after making your $25MM by plugging yourself into the right circles), but barring this (or even if you do manage this), I insist that even the rich guy needs to know at least the basics.
    - bradleyjg 12y ago
      At a minimum you should get a "fee only" adviser who has a fiduciary duty to you. You can still get bad advice, but at least you won't get corrupt advice.
abuteau 12y ago
There's ton of criticism on MPT. Would like to hear you on that ! Are they valid ? Should we use PMPT ?
- DMac87 12y ago
  Yeah, this whole "a responsible asset manager has to use MPT" is completely not true. A responsible asset manager has to consider risk and return, of course, but how they measure and evaluate risk and return is an art as much as a science. MPT-driven portfolios have been shown to underperform more naive formulations, mainly due to model risk and mis-estimation of parameters.
  - jhulla 12y ago
    I completely agree with you. MPT/PMPT systems are contingent upon accurate modeling of risk and return and this is not a science. Nassim Taleb is a vocal critic of MPT.
- jhulla 12y ago
  The primary question is this: do we truly have models that can predict future asset correlations. In other words, are our assumptions about distribution of returns valid. Behavioral economics suggests that individuals react differently than mathematically predicted. Personally, I think the biggest problem with any ideal portfolio allocation tool are black swan events (Taleb).
  - abuteau 12y ago
    How do you see value investing vs MPT then ? I often refers to a good paperon What has worked in investing [1] I think Taleb criticism is right though and he demonstrates it through Mandelbrot fractal. [1] http://www8.gsb.columbia.edu/sites/valueinvesting/files/files/what_has_worked_all.pdf http://www8.gsb.columbia.edu/sites/valueinvesting/files/file...
  - AngrySkillzz 12y ago
    If by Taleb you mean Mandelbrot, then maybe.
ryandrake 12y ago
> So what is the amateur person worth $25M to do today? A person worth $25M already has it made. They could light $1,000 a day on fire for the rest of their lives and still not go broke. Their investment options aren't really so interesting because only deliberate idiocy could destroy their retirement. I think a more useful question is, what is the amateur person worth $25K to do today? Or the young person with negative net worth? The usual "just dump it into the stock market and pray" seems very risky. Sure, long-term the overall stock market expected to go up on average, but that is if you can survive the variance. Netted out over the years, I'd guess that I've pretty much lost money on the stock market, and I'm skeptical of someone with a simple answer that amounts to "hand your money to Wall Street".
- lmm 12y ago
  > I think a more useful question is, what is the amateur person worth $25K to do today? Or the young person with negative net worth? The usual "just dump it into the stock market and pray" seems very risky. Sure, long-term the overall stock market expected to go up on average, but that is if you can survive the variance. Netted out over the years, I'd guess that I've pretty much lost money on the stock market, and I'm skeptical of someone with a simple answer that amounts to "hand your money to Wall Street". The big thing is to avoid the fees. The average money manager performs averagely, so unless you have some way of picking an above-average one, the fees you're paying are literally handing money to Wall Street. You're right to want something anticorrelated with the stock market, but everyone wants that, and paying a 2% fee to "diversify" probably costs more than you gain. I think there's some merit in the "fifty-fifty" approach - half your investment in an equity index fund, half in a cheap bond fund. But more exotic asset classes probably cost more than they're worth. The other thing is to make sure your exposure to the housing market is appropriate (indeed I've heard a three-way split suggested). If you're paying a mortgage you'll do better to pay that off quicker rather than invest in stocks or bonds. If you're wealthy enough to own outright you want some of your "excess" wealth (over what you need to own the house you want to keep) in housing, either by buying another one to rent, or by having a big enough house that you could downsize if you needed to. If you're young and renting is the really tough part: if you buy then you're insulated from the market, but relying on your ability to repay the loan. But I guess books have been written on this already.
spott 12y ago
How is MPT supposed to determine the risk in an individual security? The human element, and the number of variables under consideration seems to pretty much require MPT to be restated as "an approximation to a mathematically ideal portfolio for a given amount of risk". On the other hand, I don't know MPT at all. Can you give any info on how risk is quantified so well?
- justincormack 12y ago
  Both the risk an correlation are of course unknowns, so people use historical values, which of course are not realistic.

by jhulla 12y ago

hkmurakami 12y ago

>So what is the amateur person worth $25M to do today? As with all things, you should seek professional advice. There are many nuances of tax efficiency, estate efficiency, asset protection, personal needs, etc. that a professional advisor should guide you through. While this is true, the problem that most advisors that a $25MM net worth individual has access to are mostly duds and/or salesmen. Identifying true value add advisors is easier said than done, imo.

deleted 12y ago
[deleted]
encoderer 12y ago
Personally, i think that's more of a problem for the guy with the $500k retirement account. You will have no shortage of white gloved managers eager to help you invest your $25M. But anything short of $1MM you're solidly in Edward Jones territory. At that point you're probably better off keeping it stuffed under your mattress. If you're not a multi millionare, IMO it's worth the time to learn how to manage your own money. Because nobody will ever care as much about your money as you will. A good place to start IMO is by subscribing to the TastyTrade podcast. It's the only investing infotainment I've found that treats the listener like an adult and an equal.
- hkmurakami 12y ago
  IMHO, the quality of people you will find at your local retail branch of an ibank (think BoAML, JPMChase, WF/Wachovia, etc.) is still very shoddy and suspect. These are the channels that people have immediate access to and think of visiting, even if you have $25MM. For these retail operations, iirc the threshold is $50MM before you are shipped off to a proper PWM team at HQ. >You will have no shortage of white gloved managers eager to help you invest your $25M. How do you know which while gloved manager is actually any good though, assuming that the $25MM guy is quite naive about investment management? I believe that the small time millionaire must be up to speed on investing basics just as much as the $500k guy, in order to be able to discern the competence of his managers. I generally agree with jhulla's advice of going through a good estate planning attorney or accountant to find decent people. If you have a network of rich friends (which you can probably make in a few years after making your $25MM by plugging yourself into the right circles), but barring this (or even if you do manage this), I insist that even the rich guy needs to know at least the basics.
  - bradleyjg 12y ago
    At a minimum you should get a "fee only" adviser who has a fiduciary duty to you. You can still get bad advice, but at least you won't get corrupt advice.

abuteau 12y ago

There's ton of criticism on MPT. Would like to hear you on that ! Are they valid ? Should we use PMPT ?

DMac87 12y ago
Yeah, this whole "a responsible asset manager has to use MPT" is completely not true. A responsible asset manager has to consider risk and return, of course, but how they measure and evaluate risk and return is an art as much as a science. MPT-driven portfolios have been shown to underperform more naive formulations, mainly due to model risk and mis-estimation of parameters.
- jhulla 12y ago
  I completely agree with you. MPT/PMPT systems are contingent upon accurate modeling of risk and return and this is not a science. Nassim Taleb is a vocal critic of MPT.
jhulla 12y ago
The primary question is this: do we truly have models that can predict future asset correlations. In other words, are our assumptions about distribution of returns valid. Behavioral economics suggests that individuals react differently than mathematically predicted. Personally, I think the biggest problem with any ideal portfolio allocation tool are black swan events (Taleb).
- abuteau 12y ago
  How do you see value investing vs MPT then ? I often refers to a good paperon What has worked in investing [1] I think Taleb criticism is right though and he demonstrates it through Mandelbrot fractal. [1] http://www8.gsb.columbia.edu/sites/valueinvesting/files/files/what_has_worked_all.pdf http://www8.gsb.columbia.edu/sites/valueinvesting/files/file...
- AngrySkillzz 12y ago
  If by Taleb you mean Mandelbrot, then maybe.

ryandrake 12y ago

> So what is the amateur person worth $25M to do today? A person worth $25M already has it made. They could light $1,000 a day on fire for the rest of their lives and still not go broke. Their investment options aren't really so interesting because only deliberate idiocy could destroy their retirement. I think a more useful question is, what is the amateur person worth $25K to do today? Or the young person with negative net worth? The usual "just dump it into the stock market and pray" seems very risky. Sure, long-term the overall stock market expected to go up on average, but that is if you can survive the variance. Netted out over the years, I'd guess that I've pretty much lost money on the stock market, and I'm skeptical of someone with a simple answer that amounts to "hand your money to Wall Street".

lmm 12y ago
> I think a more useful question is, what is the amateur person worth $25K to do today? Or the young person with negative net worth? The usual "just dump it into the stock market and pray" seems very risky. Sure, long-term the overall stock market expected to go up on average, but that is if you can survive the variance. Netted out over the years, I'd guess that I've pretty much lost money on the stock market, and I'm skeptical of someone with a simple answer that amounts to "hand your money to Wall Street". The big thing is to avoid the fees. The average money manager performs averagely, so unless you have some way of picking an above-average one, the fees you're paying are literally handing money to Wall Street. You're right to want something anticorrelated with the stock market, but everyone wants that, and paying a 2% fee to "diversify" probably costs more than you gain. I think there's some merit in the "fifty-fifty" approach - half your investment in an equity index fund, half in a cheap bond fund. But more exotic asset classes probably cost more than they're worth. The other thing is to make sure your exposure to the housing market is appropriate (indeed I've heard a three-way split suggested). If you're paying a mortgage you'll do better to pay that off quicker rather than invest in stocks or bonds. If you're wealthy enough to own outright you want some of your "excess" wealth (over what you need to own the house you want to keep) in housing, either by buying another one to rent, or by having a big enough house that you could downsize if you needed to. If you're young and renting is the really tough part: if you buy then you're insulated from the market, but relying on your ability to repay the loan. But I guess books have been written on this already.

spott 12y ago

How is MPT supposed to determine the risk in an individual security? The human element, and the number of variables under consideration seems to pretty much require MPT to be restated as "an approximation to a mathematically ideal portfolio for a given amount of risk". On the other hand, I don't know MPT at all. Can you give any info on how risk is quantified so well?

justincormack 12y ago
Both the risk an correlation are of course unknowns, so people use historical values, which of course are not realistic.