In 1952, in the “Journal of Finance”, Harry Markowitz presented a theory that ultimately won him the Nobel Prize.  It’s called Modern Portfolio Theory and it has been the bedrock for how financial institutions have built their portfolios for the past 50 years.  But new research is now telling us that this industry bedrock concept for building a portfolio is nothing more than theory, and it turns out to not actually work in the marketplace.

http://www.investmentnews.com/article/20120419/FREE/120419912

Modern Portfolio Theory (MPT) requires a basic assumption, that over time, higher risk positions pay a higher return.  Yet research throughout the world is providing evidence that the reverse is actually true.

“Veteran quantitative investment analyst and economist Robert Haugen studied every stock market in the world from 1990 to 2011 and found that the average return of the least volatile stocks outperformed the most volatile stocks by an average of 17 percentage points.  We found that in every one of the world’s markets, higher volatility equals lower returns, Mr. Haugen said. Does this fly in the face of modern portfolio theory? You’re damn right it does.”

In previous posts, I’ve highlighted a ground-breaking study from the Putnam Institute (https://content.putnam.com/literature/pdf/PI001.pdf) that discusses how retirees should have no more than 25% of their portfolio in the stock market due to the fact that the extra potential returns are not worth the risk.  When the Institute’s director, W. Van Harlow, was interviewed on the results of this study, he was quoted as saying that historically, when it came to asset allocation, portfolio managers were “just guessing”.

Well, this latest research seems to agree with Mr. Harlow.

Here’s the part that I find outrageous.  You work hard all your life, you sacrifice to save some money.  Over many years you finally build a nest egg so that you can achieve some measure of financial comfort in your older age.  You turn over the management of your money to who you assume are professionals, and then we find out that these same professionals are basically investing your money in ways that are not proven.  They are “just guessing”.

Don’t you deserve better than that?

I believe that this is a big part of what is fueling the tidal wave coming down on Wall Street.  Through their actions, they think it’s ok to experiment with your hard-earned dollars.  And when it goes wrong, like it did in 2008, they wash their hands and admit no fault.  They don’t pay, you do.

And I believe you do deserve better.

The good news is that here in the US we’ve had a nice few years in the markets.  The bad news is that the Big Bad Bear is coming soon.  Why?  Euro-contagion.

Remember how in 2008 our credit markets dried up and Lehman collapsed?  We went into a deep recession and dragged Europe down with us.  And then last year we almost saw the same thing in reverse when Greece went down.

But Greece is very small, so when it fell, the domino wasn’t big enough to set off the others.  It just caused a little bit of shaking.

Spain, on the other hand, is a different story.  And Spain is in BIG trouble.

I’ve attached a great slideshow of 14 economic reports on Spain below(some include Italy, also in trouble).  If you take a moment to watch them, you’ll see a country that’s about to follow Greece’s path.  It’s not a question of if, it’s a question of when.  And “when” it does, contagion will spread.

http://www.businessinsider.com/chart-on-the-spanish-economy-2012-4#the-spanish-pmi-predicts-sharply-negative-gdp-1

Here are a couple of jaw dropping tidbits:

• Overall unemployment is 23.6%
• Unemployment for younger citizens (below age 25) is 50.5% (NOT a typo!)

These are Great Depression numbers, and I don’t see anyone over here in the US warning us about it.

From an investment perspective, it’s time to look at your portfolio to see if you are over-exposed to market risk (hint:  The Putnam Institute says more than 25% of your portfolio in the market is too much – https://content.putnam.com/literature/pdf/PI001.pdf).  2008 market conditions could easily come again soon, and you don’t want to see your portfolio get slammed again.

It’s time to learn from your mistakes, before it’s too late.  Aren’t you so glad you are following our system on the trend of the market so you dont loss huge amounts?  Make sure you pass this on to your friends and family that you are concerend about or better yet send their email address and we will add them to the list so they get this email newsletters weekly.

Can even good markets get you into trouble?  Of course they can but maybe in a different way.  I recently came across a person who represented just that.

“Betty”(not her real name of course) came in to see me for some advice on planning for her retirement.  She has been fortunate enough to accumulate over $1.5 million.

Based on her income goals, we determined that her portfolio was large enough to easily satisfy her income needs along with leaving enough money left over for the extras in life.  She had clearly reached the point of financial security.

After sharing this good news, we recommended that she start scaling back her risk levels to something more appropriate for someone who is about to enter retirement.  You make your money taking risk in the markets, then as you retire, you start scaling back to protect what you’ve earned.  This however, is when things started getting off track.

Betty’s response was this:  “why should I cahnage my investments to lower risk when I’m making so much this year?”

The answer, of course, is that markets don’t always go up, and she can lose her gains even faster than she made them.  One bad week in the market, and all her gains for the year will vanish. Also, how that can affect your retirement income as well.

But here’s the bigger point.  Because the market has done well recently, she couldn’t bring herself to make the appropriate changes for her situation.  And guess what will happen to her when the markets do go the other way, as we all know they will at some point.

Betty will, in all likelihood, see a big chunk of her portfolio disappear.  And then she’ll be kicking herself for not listening to us.  And then she’ll be saying things like, “when I finally make back what I lost, I’ll change then”.

The problem with this is that she said the exact same thing after 2008!  She lost a bunch of money, and vowed to move to more safety when she made it back.  Well, she’s made it back, but now she doesn’t want to move to safer positions because she’s scared she miss out on some potential future market gain.

The sad news about this is that a future gain will have very little positive impact on her life.  She currently has more money than she will ever spend.  If she makes more, she just leaves more to someone.  But a loss can represent a significant impact on her life.  She can easily go from financial security to financial insecurity in a heartbeat.

All because she can’t get away from the market doing well.

It’s just like Las Vegas.  You get on a run and you see your chips grow.  You know you should get up and leave with a gain, but you stay.  And then you see all your chips go away.

The moral of the story:  get up from the table, and put some of your chips in your pocket.  You’ll be glad you did.