The definition of insanity
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[quote=Ron 14]Modern Portfolio Theory - A theory on how risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward.
Markowitz wrote his book in 1959 so I don't see how you started before MPT came on the scene. Maybe it wasn't as popular or an industry wide philosophy, but it was around. The theory is based on risk. It doesn't say an investor will not see their investments decline in value over a period of time. If an investor is completely risk averse that investor still needs to spread their assets among different classes because, as we all know, long term funds in cash are at risk. A balanced strategy, invested using index funds and/or ETF's, rebalanced annually did 5.9%/yr. What is wrong with that ? With a 1 year low of -21.6%. If people can't handle a bad stretch then they just don't understand investments. Those same people saw their home value go down more in that same year, are they selling it out to the first buyer ? It is about constructing portfolios that will get them to their financial goals and coaching them along the way to stick with the plan. Jumping in and out, changing philosophies, not trusting what has worked for decades, getting spooked every so often because the herd drives the market well below its value ? These practices define insanity. I am not trying to be critical. We all develop different thoughts and ideas over time. I do think that changing core beliefs on the run can have negative consequences. [/quote] Ron this sounds like what i'd expect to hear at the fee based seminar. Markowitz won the Noble in 1990. So, while it may have been bouncing around out there it didn't gain acceptance until after that point. Wall Street embraced it as justification to fee up clients begining around 1992. Full steam ahead by 1995. 5.9%? Really? How about the investors who bought in Oct 2007? Did they get 5.9%? How about those who bought in aug 2008? How did they do? Did they get 5.9%? How many years of chugging along at 5.9% do you need to get back a 25% loss? How about a 40% loss?Not from me. A definition search online. Either way I understand what you are saying.MPT has been around for a while, but it wasn’t widely used as the basis for financial recommendations until much, much later.
Also, people are selling out of their homes, or not paying the mortgages. They are starting to realize that homes are really not investments.
I agree that jumping in and out is bad, but a lot of firms have been using MPT as if it were gospel, when in fact, it is far from it.
Also, in your first sentence you state that MPT is a theory on how risk-averse investors can maximize expected return based on a given level of risk. In fact, one of the key assumptions of MPT is that investors want to maximize profit regardless of any other considerations. But if everybody is following MPT, that tenet is untrue.
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Ron this sounds like what i'd expect to hear at the fee based seminar. Markowitz won the Noble in 1990. So, while it may have been bouncing around out there it didn't gain acceptance until after that point. Wall Street embraced it as justification to fee up clients begining around 1992. Full steam ahead by 1995. 5.9%? Really? How about the investors who bought in Oct 2007? Did they get 5.9%? How about those who bought in aug 2008? How did they do? Did they get 5.9%? How many years of chugging along at 5.9% do you need to get back a 25% loss? How about a 40% loss? [/quote] Well what if you bought in Mar of 09 or Nov 08 ? You can cherry pick time frames all day long. People are saying this was "the lost decade." Yeah, the decade sucked, two big crashes. That doesn't mean the global equity market will cease to produce returns that will get clients to their financial goals moving forward. And even though the decade was a bad one it wasn't a world ender. Investments contain risk. Home ownership contains risk. Bank Cd's contain risk. It all contains risk. Having a systematic plan to manage that risk and to prevent panic and euphoria is our value.I’m with BG, not just because I honestly believes that he has to get his pants tailored to hold the basketball sized gourds he walks around with, but also because I think that the “asset allocation model” that firms have been pimping for years is overrated, and certainly is not for every investor.
The theory has a much more plausible application if you are running a pension or endowment, who have no defined target date for use of funds (or a perpetual one, however you want to look at it). If you are a person who plans on creating a net change to the flows of a portfolio (i.e. go from contributing to withdrawing at some point), owning the amount of risk assets that most firms recommend is dangerous. 2008 should be the lesson for that. The deviation from the mean swings far too wildly in many "allocated" portfolios (at least the ones your typical advisor would use) for it to be a practical fit for someone with such a target date, especially when you consider the return is only marginally better than a well diversified bond portfolio. I know, I know..."but SN, the xyz index has gone up an average of 12% a year for the last 100 years". Right. That's awesome if you are Yoda the Jedi Master or Methuselah, but for most investors who actually have a relatively short horizon when you compare it to a secular market cycle that can be too much to bear. And if you believe that the volatility that was experienced in this decade will be more of the norm, you have to take a long look at more stable returns... ...or go buy an EIA from Biofreeze (just kidding ) Just .02 from the new guy.[quote=Ron 14]Modern Portfolio Theory - A theory on how risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward.
Markowitz wrote his book in 1959 so I don't see how you started before MPT came on the scene. Maybe it wasn't as popular or an industry wide philosophy, but it was around. The theory is based on risk. It doesn't say an investor will not see their investments decline in value over a period of time. If an investor is completely risk averse that investor still needs to spread their assets among different classes because, as we all know, long term funds in cash are at risk. A balanced strategy, invested using index funds and/or ETF's, rebalanced annually did 5.9%/yr. What is wrong with that ? With a 1 year low of -21.6%. If people can't handle a bad stretch then they just don't understand investments. Those same people saw their home value go down more in that same year, are they selling it out to the first buyer ? It is about constructing portfolios that will get them to their financial goals and coaching them along the way to stick with the plan. Jumping in and out, changing philosophies, not trusting what has worked for decades, getting spooked every so often because the herd drives the market well below its value ? These practices define insanity. I am not trying to be critical. We all develop different thoughts and ideas over time. I do think that changing core beliefs on the run can have negative consequences. [/quote] You're right Ron. It worked for decades. Some decades. If you were the unlucky sap that retired in 1900-1915ish, 1927-1940's, 1968-1975ish, 1998-2008, then it didn't work so well. You were real lucky if you retired in the 50's, or 80's or early 90's. Go back and look at the charts. No, not the deceiving mountain charts put out by the fund companies that show the S&P if you invested $10,000 100 years ago. The one that shows the level of the S&P for the past 100 years. And then look at one adjusted for inflation. Shocking to say the least. It might changed your mind on "buy and hold and wait it out. Why the huge variability in returns? It's not earnings and GDP growth. That has been pretty consistent over the years. Inflation? Nope. Interest rates? Nope. Black Swans. Big events that upset the entire apple cart and changed the P/E ratio in the market. We went from a 44 P/E on the S&P in 2000 to a 13 in 2008. Did people stop spending? Did people stop working? Did companies shut down? Did people stop brushing their teeth? (an American Funds favorite). No. Something disrupted the economic universe. And your stock that was worth $50 was now worth $25. Nothing any buy-and-hold strategy could defeat. Thank goodness the market has come back. We are only short about 35% from the peak. If the market had dipped to a P/E that was reflective of prior bear markets (mid to upper single-digits), we would have been at Dow 4500 or so. I would much rather have gotton out at Dow 12,000 (from 14,000) than ridden it all the way down. And so would your clients. Better yet, out at Dow 12,000 and over half your money protected from the stock market to begin with, and actually MAKING money in 2008. Not saying it's easy. But there are other ways.This always comes back around to the same thing. Ok. Asset Allocation is crap, its just a model to help firms keep people in the market, pile up fees, blah blah blah. Then what is the answer ? What do you do for your clients ? What are the core principles you are building your practice on ?
I am not trying to piss anyone off I just want a healthy debate. Give me a break !I am not referring to 100 year mountain charts from American Funds. I am talking specifically about the last 10 years of garbage.[quote=Ron 14]
Well what if you bought in Mar of 09 or Nov 08 ? You can cherry pick time frames all day long. People are saying this was "the lost decade." Yeah, the decade sucked, two big crashes. That doesn't mean the global equity market will cease to produce returns that will get clients to their financial goals moving forward. And even though the decade was a bad one it wasn't a world ender. Investments contain risk. Home ownership contains risk. Bank Cd's contain risk. It all contains risk. Having a systematic plan to manage that risk and to prevent panic and euphoria is our value. [/quote] Cherry picking? What would you call 5.9%? It's all cherry picking. And much of it is lying with statistics. Of course the global economy will perk along and equities belong in all long term investor accts. That's not in question. The problem is we, as in the street in general not you personally, doesn't have a systematic plan to manage risk. MPT is sold as that plan but clearly, it hasn't protected investors. Another word on cherry picking. Ok, fair enough, i can pick periods that show poor performance and the counter arguement can hand pick good periods. Neither is the point. The point is the 50 something pre-retiree who doesn't have time to rebuild if we fall off the tracks. That person doesn't get to cherry pick. They are operating in real time. They need the growth equities can provide, but can't stand a catastrophic wipeout. How do we protect that investor? It's time for the street to go back to telling investors not only what to buy, but when to buy. Tech analysis anyone?BG - there isn’t going to be a systematic plan, because the economy is too dynamic. The biggest issue is that most advisors are salespeople and are very good at selling. Financial management is a different craft and one that most of us aren’t experts in. Oh, there is bluster on the boards about such things, but in reality MPT has been a godsend for financial companies, because it allows advisors to work within a certain framework.
How many people will take the time to actually become experts in finance? Maybe people who have been doing it for so long you naturally learn things. But advisors are going to become pretty scare if there isn’t a framework to follow. And then you won’t have enough advisors for everybody.
We apply much of financial and economic theory using social science statistical models, when we should more likely use chaos models (non-linear, asymmetric). Our business is incredibly complex and further complicated because of human nature.
I’m not sure we should be tech analysts, but it is an option, and one that can be explored. But like anything else, it would need to be tested on a relatively consistent basis to insure that it is working.
All strategies need to be tested on a consistent basis.
It is prospecting. Toss out the line, see what "develope"s. They might do better if they learned how to spell develop! Hahahaha!
Much of it comes back to timing. There are times that are just not real good to be invested in equities.
Ron, do yourself a favor (I don't mean to sound condescending), read Unexpected Returns by Ed Easterling (Crestmont Research). It will open your eyes. I read the first version a few years back. They have an updated version out. Basically, it talks about the fact that there are times when you can look at the value of a market and know, with almost certainty, that your future potential returns are doomed. There is simply no way to make money. 1998-2000 was a perfect example. It was clear beyond clear (unless you prescribed to the "New Paradgim") that there was simply no way you could make money going forward putting money into a 40+ P/E market. Conversely, investing heavily in equities when the market P/E was 8 or 9 made sense. You ALWAYS made money. The long cycles (secular cycles) ebb and flow. You need to know where you are in the cycle. When you DON'T know (like now - are we at the beginning, middle or end??), you need to be in "protection" mode, and seek the least risky assets (which is not always what we consider the "least risky " assets like cash or Treasuries - right now, both of those would be poor choices). But simply dumping 60% into equities and 30% into bonds, and 10% into cash is making an assumption that a market P/E of 44 is the same as a market P/E of 7. I think MPT is a perfect starting point, or reference point. A well-balanced portfolio of stocks, bonds, alternatives, and cash. But you need to look at the balance among them during given market cycles. Portfolios cannot just be static representations of a market that is anything BUT static.[quote=BondGuy][quote=Ron 14]
Well what if you bought in Mar of 09 or Nov 08 ? You can cherry pick time frames all day long. People are saying this was "the lost decade." Yeah, the decade sucked, two big crashes. That doesn't mean the global equity market will cease to produce returns that will get clients to their financial goals moving forward. And even though the decade was a bad one it wasn't a world ender. Investments contain risk. Home ownership contains risk. Bank Cd's contain risk. It all contains risk. Having a systematic plan to manage that risk and to prevent panic and euphoria is our value. [/quote] Cherry picking? What would you call 5.9%? It's all cherry picking. And much of it is lying with statistics. Of course the global economy will perk along and equities belong in all long term investor accts. That's not in question. The problem is we, as in the street in general not you personally, doesn't have a systematic plan to manage risk. MPT is sold as that plan but clearly, it hasn't protected investors. Another word on cherry picking. Ok, fair enough, i can pick periods that show poor performance and the counter arguement can hand pick good periods. Neither is the point. The point is the 50 something pre-retiree who doesn't have time to rebuild if we fall off the tracks. That person doesn't get to cherry pick. They are operating in real time. They need the growth equities can provide, but can't stand a catastrophic wipeout. How do we protect that investor? It's time for the street to go back to telling investors not only what to buy, but when to buy. Tech analysis anyone? [/quote] Maybe I missed something, but I thought we were talking about recent history and how you believe MPT failed investors. I chose the last 10 years because it was terrible period in the equity markets to show a balanced portfolio didn't kill anyone. My parents are 55. They have what many would call a balanced portfolio. They lost 23% in 2008. They have more money to invest now than at any period because home is nearly paid off and kids are gone. One of them is likely to live beyond 85. That is a 30 year time frame and they will need 4% withdrawals. Why is a bland, low expense, diversified portfolio, rebalanced annually, with 12 months living expenses in cash a bad thing ? If you can systematically buy and sell stocks for profit by using analysis you should not have any clients. You should trade your own account and keep all the profits.[quote=B24]Much of it comes back to timing. There are times that are just not real good to be invested in equities.
Ron, do yourself a favor (I don't mean to sound condescending), read Unexpected Returns by Ed Easterling (Crestmont Research). It will open your eyes. I read the first version a few years back. They have an updated version out. Basically, it talks about the fact that there are times when you can look at the value of a market and know, with almost certainty, that your future potential returns are doomed. There is simply no way to make money. 1998-2000 was a perfect example. It was clear beyond clear (unless you prescribed to the "New Paradgim") that there was simply no way you could make money going forward putting money into a 40+ P/E market. Conversely, investing heavily in equities when the market P/E was 8 or 9 made sense. You ALWAYS made money. The long cycles (secular cycles) ebb and flow. You need to know where you are in the cycle. When you DON'T know (like now - are we at the beginning, middle or end??), you need to be in "protection" mode, and seek the least risky assets (which is not always what we consider the "least risky " assets like cash or Treasuries - right now, both of those would be poor choices). But simply dumping 60% into equities and 30% into bonds, and 10% into cash is making an assumption that a market P/E of 44 is the same as a market P/E of 7. I think MPT is a perfect starting point, or reference point. A well-balanced portfolio of stocks, bonds, alternatives, and cash. But you need to look at the balance among them during given market cycles. Portfolios cannot just be static representations of a market that is anything BUT static.[/quote] I would venture to say that market P/E's don't often fluctuate outside of a certain range. I don't know for sure, but lets say a majority of the time they are between 16-22. Now what, you sit around and wait for a move either way? It seems to be that rebalancing is an easier way of selling high and buying low when the extremes aren't in play.[quote=Ron 14][quote=B24]Much of it comes back to timing. There are times that are just not real good to be invested in equities.
Ron, do yourself a favor (I don't mean to sound condescending), read Unexpected Returns by Ed Easterling (Crestmont Research). It will open your eyes. I read the first version a few years back. They have an updated version out. Basically, it talks about the fact that there are times when you can look at the value of a market and know, with almost certainty, that your future potential returns are doomed. There is simply no way to make money. 1998-2000 was a perfect example. It was clear beyond clear (unless you prescribed to the "New Paradgim") that there was simply no way you could make money going forward putting money into a 40+ P/E market. Conversely, investing heavily in equities when the market P/E was 8 or 9 made sense. You ALWAYS made money. The long cycles (secular cycles) ebb and flow. You need to know where you are in the cycle. When you DON'T know (like now - are we at the beginning, middle or end??), you need to be in "protection" mode, and seek the least risky assets (which is not always what we consider the "least risky " assets like cash or Treasuries - right now, both of those would be poor choices). But simply dumping 60% into equities and 30% into bonds, and 10% into cash is making an assumption that a market P/E of 44 is the same as a market P/E of 7. I think MPT is a perfect starting point, or reference point. A well-balanced portfolio of stocks, bonds, alternatives, and cash. But you need to look at the balance among them during given market cycles. Portfolios cannot just be static representations of a market that is anything BUT static.[/quote] I would venture to say that market P/E's don't often fluctuate outside of a certain range. I don't know for sure, but lets say a majority of the time they are between 16-22. Now what, you sit around and wait for a move either way? It seems to be that rebalancing is an easier way of selling high and buying low when the extremes aren't in play. [/quote] Rowing versus sailing. When times are good, as you have suggested, and markets are in equilibrium (think 1983-1998), you just sit tight and keep rebalancing (sailing). Yes, bull markets are longer and deeper than bears. But when you do hit the extremes, that is the time for action. Extended bull markets have always been followed by devastating bear markets. Most people aren't lucky enough to have all their money ready to be invested at the beginning of a secular bull market. You just have to have a plan (rowing). And there is a difference between the plan for a 35 year-old and a 60 year-old. And since most of our clients are closer to 60 than 35, you better have a pretty good plan.[quote=BondGuy][quote=Ron 14]
Well what if you bought in Mar of 09 or Nov 08 ? You can cherry pick time frames all day long. People are saying this was "the lost decade." Yeah, the decade sucked, two big crashes. That doesn't mean the global equity market will cease to produce returns that will get clients to their financial goals moving forward. And even though the decade was a bad one it wasn't a world ender. Investments contain risk. Home ownership contains risk. Bank Cd's contain risk. It all contains risk. Having a systematic plan to manage that risk and to prevent panic and euphoria is our value. [/quote] Cherry picking? What would you call 5.9%? It's all cherry picking. And much of it is lying with statistics. Of course the global economy will perk along and equities belong in all long term investor accts. That's not in question. The problem is we, as in the street in general not you personally, doesn't have a systematic plan to manage risk. MPT is sold as that plan but clearly, it hasn't protected investors. Another word on cherry picking. Ok, fair enough, i can pick periods that show poor performance and the counter arguement can hand pick good periods. Neither is the point. The point is the 50 something pre-retiree who doesn't have time to rebuild if we fall off the tracks. That person doesn't get to cherry pick. They are operating in real time. They need the growth equities can provide, but can't stand a catastrophic wipeout. How do we protect that investor? It's time for the street to go back to telling investors not only what to buy, but when to buy. Tech analysis anyone? [/quote] That is what I use and nothing else..math never lies...[quote=B24][quote=Ron 14][quote=B24]Much of it comes back to timing. There are times that are just not real good to be invested in equities.
Ron, do yourself a favor (I don't mean to sound condescending), read Unexpected Returns by Ed Easterling (Crestmont Research). It will open your eyes. I read the first version a few years back. They have an updated version out. Basically, it talks about the fact that there are times when you can look at the value of a market and know, with almost certainty, that your future potential returns are doomed. There is simply no way to make money. 1998-2000 was a perfect example. It was clear beyond clear (unless you prescribed to the "New Paradgim") that there was simply no way you could make money going forward putting money into a 40+ P/E market. Conversely, investing heavily in equities when the market P/E was 8 or 9 made sense. You ALWAYS made money. The long cycles (secular cycles) ebb and flow. You need to know where you are in the cycle. When you DON'T know (like now - are we at the beginning, middle or end??), you need to be in "protection" mode, and seek the least risky assets (which is not always what we consider the "least risky " assets like cash or Treasuries - right now, both of those would be poor choices). But simply dumping 60% into equities and 30% into bonds, and 10% into cash is making an assumption that a market P/E of 44 is the same as a market P/E of 7. I think MPT is a perfect starting point, or reference point. A well-balanced portfolio of stocks, bonds, alternatives, and cash. But you need to look at the balance among them during given market cycles. Portfolios cannot just be static representations of a market that is anything BUT static.[/quote] I would venture to say that market P/E's don't often fluctuate outside of a certain range. I don't know for sure, but lets say a majority of the time they are between 16-22. Now what, you sit around and wait for a move either way? It seems to be that rebalancing is an easier way of selling high and buying low when the extremes aren't in play. [/quote] Rowing versus sailing. When times are good, as you have suggested, and markets are in equilibrium (think 1983-1998), you just sit tight and keep rebalancing (sailing). Yes, bull markets are longer and deeper than bears. But when you do hit the extremes, that is the time for action. Extended bull markets have always been followed by devastating bear markets. Most people aren't lucky enough to have all their money ready to be invested at the beginning of a secular bull market. You just have to have a plan (rowing). And there is a difference between the plan for a 35 year-old and a 60 year-old. And since most of our clients are closer to 60 than 35, you better have a pretty good plan.[/quote] That is great in theory, but last spring when the Dow was at 6500 people and advisors were scared to death about buying. Very few advisors on this site, if any, were signaling to purchase equities. (there was a thread about this at the time) All numbers look terrible when the market is in the sh*tter and more often than not that is the exact time to buy. The numbers also show this is when the average investor sh*ts himself. I still haven't heard a good explanation from anyone as to what their core principles are when it comes to advising their clients. Let me ask it again... If asset allocation, diversification and rebalancing are philosophies of the past, what is the philosophy of the future ?[quote=chief123][quote=BondGuy][quote=Ron 14]
Well what if you bought in Mar of 09 or Nov 08 ? You can cherry pick time frames all day long. People are saying this was "the lost decade." Yeah, the decade sucked, two big crashes. That doesn't mean the global equity market will cease to produce returns that will get clients to their financial goals moving forward. And even though the decade was a bad one it wasn't a world ender. Investments contain risk. Home ownership contains risk. Bank Cd's contain risk. It all contains risk. Having a systematic plan to manage that risk and to prevent panic and euphoria is our value. [/quote] Cherry picking? What would you call 5.9%? It's all cherry picking. And much of it is lying with statistics. Of course the global economy will perk along and equities belong in all long term investor accts. That's not in question. The problem is we, as in the street in general not you personally, doesn't have a systematic plan to manage risk. MPT is sold as that plan but clearly, it hasn't protected investors. Another word on cherry picking. Ok, fair enough, i can pick periods that show poor performance and the counter arguement can hand pick good periods. Neither is the point. The point is the 50 something pre-retiree who doesn't have time to rebuild if we fall off the tracks. That person doesn't get to cherry pick. They are operating in real time. They need the growth equities can provide, but can't stand a catastrophic wipeout. How do we protect that investor? It's time for the street to go back to telling investors not only what to buy, but when to buy. Tech analysis anyone? [/quote] That is what I use and nothing else..math never lies...[/quote]Chief, I like your posts and think you are a smart guy. But the interpretation of math is the biggest problem.
While math may not lie, technical analysis runs into some of the same problems faced by MPT and EMH. Technical analysis as a scientific method for forecasting is inconclusive at best.
That doesn't mean it doesn't work, just that as a method for advisors to invest client assets it is just as limited as other models.
I agree I think you can get carried away with technical analysis. I stick to the basics, keep investment costs down(use etfs), and it has worked for my clients.
[quote=chief123]I agree I think you can get carried away with technical analysis. I stick to the basics, keep investment costs down(use etfs), and it has worked for my clients. [/quote]
Awesome!
To go back to BG’s OP, I wonder if it’s possible that we’re already doing things that are benefiting our clients.
Fortunately in our business, there are many ways to skin the cat. So I wonder if maybe we’re worrying over nothing.
Given the dynamic nature of global economics and the differing theories on the financial markets, it might be better for each individual to find what works and stick to it.
A unifying theory sounds nice (in theory), but I think the best thing is to continue to debate and poke holes in each others methods. It will make us better at our jobs and benefit our clients as well.
And maybe justify our fee.
Well said.[quote=chief123]I agree I think you can get carried away with technical analysis. I stick to the basics, keep investment costs down(use etfs), and it has worked for my clients. [/quote]
Awesome!
To go back to BG’s OP, I wonder if it’s possible that we’re already doing things that are benefiting our clients.
Fortunately in our business, there are many ways to skin the cat. So I wonder if maybe we’re worrying over nothing.
Given the dynamic nature of global economics and the differing theories on the financial markets, it might be better for each individual to find what works and stick to it.
A unifying theory sounds nice (in theory), but I think the best thing is to continue to debate and poke holes in each others methods. It will make us better at our jobs and benefit our clients as well.
And maybe justify our fee.
Great thread.
What I take from BG’s original post is that we should pay attention to what the client is hearing us say. ‘Asset allocation’ and ‘diversification’ probably sound great to us, but how does that get a prospect excited?
What does the prospect or client want?
My opinion is that he wants some kind of income or distribution strategy and not a growth strategy.
Our clients are older now (boomers are starting to retire) and more concerned with distribution strategies rather than growth strategies; also, the economic times are far more uncertain.
So my evolving POV is to tell prospects that we will protect their money, generate predicatable, guaranteed income whenever possible and only put long term (10 years and out money) in stocks, ideally with a GMAB.
When a man is 45 he wants to grow his money at all costs. At 65, he’s wiser, more cautious and wants different things.