Our Nobel Laureate Consultant
Harry Markowitz
"In choosing a portfolio, investors should seek broad diversification,
Further, they should understand that equities--and corporate bonds also--involve
risk; that markets inevitably fluctuate; and their portfolio should be such that
they are willing to ride out the bad as well as the good times."
- Harry Markowitz, October 7th, 2008
The 1990 Nobel Prize Winner and IFA Academic Consultant
Harry Max Markowitz is an economist at the Rady School of Management at the University of California, San Diego. He is best known for his pioneering work in Modern Portfolio Theory, studying the effects of asset risk, correlation and diversification on expected investment portfolio returns. Dr. Markowitz is also the recipient of the 1989 John von Neumann Theory Prize.
In 1952, Harry Markowitz developed the simple, but profound notion that investors must consider not only return, but the risk associated with their investments. Markowitz’s ground-breaking discovery earned him the 1990 Nobel Prize in Economics, and sparked the financial revolution called: Modern Portfolio Theory. Markowitz is widely known as the father of Modern Portfolio Theory.
Meeting of the Minds
Nobel Prize Level Education (Stay up to date with
IFA's News Letter)
September 20, 2010 - 
Can You Do Well While Doing Good?
Harry M. Markowitz analyzes how much is lost by confining investments to a socially responsible universe.
Click here to read the full article
October 28, 2009 -
Portfolio Theory
and 2008
Harry M. Markowitz explains Portfolio Theory: what it is and how it's used from
a top-down model from the asset classes to the investmens. He covers Standard
Deviation, Variance, Correlation, and Covariance. Markowitz also explains what
happened in 2008 with Modern Portfolio Theory. (39 Min.)
Click here to see the video.
July 7, 2009 - IFA Exclusive!
Harry Markowitz article discusses Portfolio Theory and IFA Research
Does Portfolio Theory Work During Financial Crises? 
Click here to read the full article.
April 21, 2009 -
Portfolio Theory
Vs. Financial Engineering, and Their Roles in Financial Crises
Harry Markowitz gives an IFA Exclusive Presentation on Portfolio Theory Vs.
Financial Engineering, and Their Roles in Financial Crises. Markowitz explains
the difference between Portfolio Theory and Financial Engineering. Markowitz
also covers Black Monday (October 19, 1987), Long Term Capital Management, and
Now. (47 Min.)
Click here to see the video.
October 22, 2008 - Nobel Prize Winner and IFA Academic
Consultant, Harry Markowitz outlines a solution for resolving the current
financial crisis:
The current financial crisis is a
combination of three ill winds that combined to make the “perfect” storm. One
ill wind is the bursting of the real estate bubble; the second is the ongoing
consequences of the subprime and near-subprime mortgage fiasco; the third...
Click here to read the full article.
"It's like a crapshoot in Las Vegas, except in Las Vegas the odds are with the house. As for the market, the odds are with you, because on average over the long run, the market has paid off."
- Harry Markowitz in "Risk Management: Improving your Odds in the Crapshoot"
from Bloomberg Personal, July 1996
Today, Harry Markowitz’s highly acclaimed research serves as the framework for
the Prudent Investor Rule, as well as for the investment strategies of
institutional investors around the world. It is estimated that some $7 trillion
dollars in institutional assets are invested in accordance with Professor
Markowitz’s Nobel-Prize winning discoveries.
Markowitz’s research supports IFA’s investment strategy: A portfolio that
carries broad-based diversification among low-cost and passively managed indexes
has shown to be the most prudent investing strategy over time.
"Don't bet the ranch.
Get more bang for your buck.
Maximize output relative to input.
Nothing ventured, nothing gained.
Diversify instead of striving to make a killing.
Don't put all your eggs in one basket; if it drops, you're in trouble.
High volatility is like putting your head in the oven and your feet in the
refrigerator."
These common sense sayings capture the essence of Harry Markowitz's brainstorm,
sparked one afternoon as he sat in the University of Chicago library reading a
book about the current thinking of stock market investing. At 25 years old,
Markowitz thought investors should be equally concerned with the volatility or
risk of investments as they are with the return of investments. Thirty-eight
years later, this innovative, practical theory earned him the 1990 Nobel Prize
in Economics. This landmark contribution to the investment world was first
published in 1952 in an essay entitled, "Portfolio Selection." He later authored
a book entitled, Portfolio Selection: Efficient Diversification (1959).
Using several stocks from the
New York Stock Exchange, Harry Markowitz created the first efficient frontier.
The image below and to the left is reproduced from his book, Portfolio
Selection, Cowles Monograph 16, Yale University Press, 1959. It has a line going
to the origin, because Markowitz was interested in the effects of combining
risky assets with a riskless asset: cash.
A more modern version of the efficient frontier is
found above. Notice that the axis labels have been reversed. (source:
schwab.com).
The theory developed in Portfolio Selection was a theory for optimal investment
in stocks that differ in regard to their expected return and risk. Investment
managers and academic economists have long been aware of the necessity of taking
both risk and return into account. Markowitz's primary contribution consisted of
developing a rigorously formulated operational theory for portfolio selection
under uncertainty. His theory evolved into a foundation for further research in
financial economics. Markowitz was the first to place a number on risk relative
to investing. Risk was previously discussed in general terms and based more on
feeling or intuition. He was able to quantify the "undesirable thing" an
investor tries to avoid by using a range of possible return outcomes, based on
the past variability of returns.
Under certain conditions, Markowitz showed an investor's portfolio choice can be
reduced to balancing two dimensions: the expected return on the portfolio, and
its variance or standard deviation. The risk of a diversified portfolio depends
not only on the individual variances of the return on different assets, but also
on the opposite movement of all assets. When one asset class goes up, another
goes down. The opposite movement results in a higher return than if all of the
assets go up or down together. He said, "Diversification is both observed and
sensible. A rule of behavior which does not imply the superiority of
diversification must be rejected both as a hypothesis and as a maxim." At
twenty-five, Markowitz already knew that focusing on return without proper
consideration of risk creates portfolios that are less than desirable.
Markowitz's contribution extended to making the distinction between the risk of
an individual stock and the risk of a portfolio. He showed how individual risky
stocks lose much of their risk if combined with less risky stocks in a
portfolio. What is remarkable about Markowitz's discovery is that an investor
can reduce the volatility of a portfolio and increase its return at the same
time.
When Markowitz began to formulate his ideas in the 1950’s, leading investment
guides recommended that an investor should find one stock with the highest
expected return, invest in it, and ignore all the others. If investing involved
no amount of risk, holding investments with the highest expected returns would
be a highly profitable idea. The experienced investor knows that investing is
full of risk. Risk essentially means that more can happen than will happen,
which adds great uncertainty to investment decision-making. People do not expect
to be in an auto accident, but they invest in auto insurance because of the
unpredictable possibilities. People also do not expect a stock in their
portfolio to decrease in price, but it can and will at some point. If an
investor’s portfolio is diversified, then the loss incurred from that one stock
will be “insured” by other stocks that do not decrease in price. Markowitz knew
that in the real world, investors are not only interested in return, but they
are concerned with risk as well.
Markowitz concluded that risk is central to the whole process of investing. He
then wondered how to measure the appropriate amount of risk to undertake.
Markowitz came to realize the cruel truth of investing: investors cannot earn
higher returns without taking on greater risk, and the greater the risk, the
greater the possibility of loss. He set out to devise ways to help investors
apply tradeoffs between risk and return. Using mathematics to solve the puzzle,
Markowitz discovered a remarkable new way to build an investment portfolio,
which he called the "efficient portfolio.” It offers an investor the highest
expected return for any given level of risk, or the lowest level of risk for any
given expected return.
"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."
- Harry Markowitz in his 1959 book "Portfolio Selection: Efficient Diversification of Investments"