Wednesday Wealth Recap:
- The market saw a jump in coronavirus cases and began a sell-off last week. But then it recovered. Alexander Green explains what’s going on with the economy and the market in his latest video update.
- Speaking of the U.S. economy… Have you ever wondered how it stacks up against the rest of the world’s economies? Nicholas Vardy answers that question right here.
- With reports of increasing coronavirus cases and unemployment, it may seem tough to be optimistic at a time like this. But, as Senior Macroeconomic Analyst Matt Benjamin shared this week, many of us still prefer to look on the bright side.
- And if you’re feeling optimistic but don’t have the moola to plunk down for market darlings like Amazon ($2,600 a share) or Berkshire Hathaway ($273,000 a share), our friend Andy Snyder has a solution for you.
“To reduce risk it is necessary to avoid a portfolio whose securities are all highly correlated with each other.”
– Harry Markowitz
Last month I had the supreme experience of having lunch in La Jolla, California, with the father of modern portfolio theory, Harry Markowitz. He is considered a legend on Wall Street.
The lunch was arranged by Rob Arnott, a successful financial consultant known as the godfather of smart beta. He is also a strong advocate of value investing and will be a keynote speaker at this year’s FreedomFest.
Mark Skousen (center), pictured with Harry Markowitz (left) and Rob Arnott (right).
Markowitz is a legend in the investment world. He won the Nobel Memorial Prize in economics in 1990 based on a single article he wrote for The Journal of Finance in 1952 called “Portfolio Selection.”
It was a eureka moment when he discovered that investors could increase their returns and reduce risk by properly diversifying their portfolios in stocks, bonds and cash.
In choosing a portfolio, investors should seek broad diversification. Modern portfolio theory recommends that you diversify with a balance of stocks and bonds and cash that’s suitable to your risk tolerance.
For example, during the coronavirus crash in March, stocks fell but bonds rose, and a portfolio of both stocks and bonds would have survived intact.
Ditto for the financial crisis of 2008.
If you made the mistake of being invested only in stocks, you were killed. If you invested only in bonds, you missed out on the mother of all bull markets from 2009 to 2020. But by investing in both, you survived and prospered.
Markowitz’s message is clear: It’s vital to have noncorrelated investments that move in opposite directions during crises. He states…
A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies.
During the most recent bear market, most stocks fell together, from financials to utilities. However, many online-related tech stocks rose.
Five Principles of Modern Portfolio Theory
Since Markowitz wrote his trailblazing paper in 1952, economists have improved upon his work. Today, financial advisors argue in favor of five principles of modern portfolio theory. They are…
- If you want to reduce risk and increase returns, diversify your portfolio in noncorrelated investments. (This strategy doesn’t necessarily mean you will beat the market, or even match it, every year. You may go several years underperforming the market. It takes patience to work.)
- Rebalance your portfolio every year. That means selling stocks that have outperformed and adding to stocks that have underperformed. (Financial advisors admit this is the hardest thing for investors to do; it’s best to have a money manager do it for you automatically.)
- Don’t try to beat the market; buy a broad-based index fund like the SPDR S&P 500 ETF Trust (NYSE: SPY) or the Invesco QQQ (Nasdaq: QQQ) Nasdaq-100 ETF. Then you will never have to say, “Sorry, my portfolio failed to beat the market this year.”
(Note, indexing takes all the fun out of investing. In my experience, investors love to find stocks that double or triple in value in a short period of time. But it’s a risky business. The danger is that you can lose big time trying to cherry-pick individual stocks from an index.)
- Don’t try to time the market. Selling near the top and buying at the bottom are harder than you think. (Study after study has shown that the vast majority of active mutual funds, investment companies, hedge funds and private equity firms cannot time the market. Technical traders and chart analysts promise they can do it, but when you actually follow their methods, they often fall short.)
- Dollar-cost average in your tax-deferred 401(k) or IRA. Add to your account on a regular basis via automatic investment plans from your employer, bank or brokerage account. (Dollar-cost averaging is the best way to go.)
As Burt Malkiel, author of A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, notes, the benefit of dollar-cost averaging is that when stocks are down temporarily, you end up buying more stock, and when the stock market recovers, you get more bang for your buck.
Markowitz’s No. 1 Investment Now Is Not Gold, But…
I brought up gold as an excellent noncorrelated investment that often moves opposite to the stock market. The precious metal has held up well in 2020. But I was surprised to learn that gold doesn’t interest Markowitz.
Instead, he favors California real estate. He has a condo on the beach, which he says is benefiting from rising demand and cheap mortgage rates.
Markowitz is amazingly alert for a man who is 92 years old. He was born in the year Babe Ruth hit 60 home runs – 1927! He was 2 years old when the stock market crashed in 1929. He has lived through it all – World War II, the inflationary ’70s, the 1987 stock market crash, the dot-com boom and bust, and the longest bull market in history.
What Is the Most Important Lesson of Investing?
Markowitz has survived and prospered throughout the 20th and 21st centuries. Near the end of our luncheon, I asked him what, after all these years, he thought was the most important lesson of investing.
He hesitated, so I suggested one of my favorite quotes from The Maxims of Wall Street: “Wall Street exaggerates everything.”
Both he and Arnott nodded in agreement. “That’s why diversification is so important,” stated Markowitz. “It reduces the risk.”
Last Thursday’s 7% collapse in stocks is a perfect example. Not much changed fundamentally in one day, but the fickle market panicked anyway.
They were both intrigued by my new seventh edition of the Maxims, and we spent the rest of the time reading, smiling and commenting in response to various quotes from the book.
Here are some of their favorites…
“Psychology is probably the most important factor in the market – and one that is least understood.”
– David Dreman
“You can’t worry and hit home runs.”
– Babe Ruth
“Know value, not prices.”
– Arnold Bernard
“Take calculated risks, but don’t be rash.”
– Gen. George Patton
Markowitz especially liked this one from Charles Allmon: “I’m not a bull. I’m not a bear. I’m a chicken.”
He was delighted to receive an autographed copy of my book.
Arnott Buys a Box of Maxims
Arnott was so impressed that he decided to buy an entire 32-copy box, which I sell for $300. He plans to give them out to his best clients.
I also offer a super bargain price for the Maxims. The first copy is $20, and each additional copy is $10. Maxims makes a great gift for friends, family, clients and investors.
I autograph all copies, number them and mail them at no extra charge. If you order a case, you pay only $300.
To order, go to www.skousenbooks.com or call Harold at Ensign Publishing at 866.254.2057.
Dennis Gartman said it best: “It’s amazing the depth of wisdom one can find in just one or two lines from your book. I have it on my desk and refer to it daily.”
Alexander Green says, “It’s a classic!”