Yesterday morning, I attended the St. Louis Chapter of the Financial Planning Association meeting to hear a presentation titled “Modern Portfolio Theory 2.0.” It was excellent, no surprise, because it was presented by Michael Kitces MSFS, MTAX, CFP®, CLU, ChFC, RHU, REBC, CASL, whom I often describe as a “walking brain” when discussing him with peers. He is also the author of a reference book I own, and to which I often refer.
Michael came in from the Washington DC area to share his research on market and economic history, the accompanying signals and data, and what it has told us about subsequent market performance. He also had ideas for how this information could be layered on top of Modern Portfolio Theory in a tactical way to mitigate some risk in client portfolios.
Modern Portfolio Theory
In the 1950’s, Dr. Harry Markowitz pioneered the idea of considering your investment portfolio as a whole unit, rather than as individual securities, when measuring risk and expected return. He determined mathematically that you could put investments in the portfolio that had a bit more risk (more volatility) and yet create less volatility in the portfolio as a whole.
This reduction in volatility was accomplished by having investments that were not completely correlated, meaning they did not move in tandem. So when one investment zigs, another one zags. In effect, when you have multiple investments moving in different amounts of up and down directions at different times, it creates a smoother path overall.
There are different steps involved in implementing Modern Portfolio Theory. I gave a “plain English” version of the Asset Allocation step in my blog post “Peter Cottontail Makes A Lousy Investment Advisor!” which explains the reasons for diversification and rebalancing a portfolio.
Modern Portfolio 2.0
In his presentation, Michael pointed out three factors that make following Modern Portfolio Theory, without any adjustment, challenging.
- Returns – they seem to vary for an extended period of time
- Standard Deviation – there are distinct high and low volatility periods
- Correlations – became close to 1 during the recent crisis
He shared with us different valuation data points, macroeconomic information, and technical trend analysis information to evaluate when considering adjustments to Modern Portfolio Theory inputs.
I have seen Michael speak on similar topics and can see that his research is expanding; he shared more data points and ideas for implementation than in the past. I look forward to seeing where the research leads.
Michele Clark
Michele has more than 25 years experience in financial services and has developed a specialization in working with people who are starting to seriously think about their retirement or who are retired and facing all of the complex planning issues one faces during this time.
She works with clients to coordinate decisions around investments, retirement accounts, Social Security, funding health care, tax planning, cash-flow, maximizing employer benefits, charitable gifting strategies and estate planning.
Before joining Acropolis Investment Management, Michele was the founder and managing principal of Clark Hourly Financial Planning and Investment Management for nearly nine years with an additional sixteen years at banks and investment firms.
Michele has been quoted in such online and print media outlets as The Wall Street Journal, Money Magazine, USA Today, Market Watch, US News & World Report, CNBC.com, AARP, St. Louis Post Dispatch, Fox Business, Forbes, Los Angeles Times, Financial Planning Magazine, St. Louis Public Radio, Yahoo Finance, St. Louis Magazine, and others.
Michele earned her B.A. from Purdue University. She is a CERTIFIED FINANCIAL PLANNER® practitioner, obtained the Chartered Retirement Planning Counselor (CRPC®) designation from the College for Financial Planning, and is a NAPFA Registered Investment Advisor.
Michele has volunteered her time for financial literacy outreach at Financial Planning Days, Money Smart Week, Habitat for Humanity and others.
Michele has served on the Board of Directors of the Financial Planning Association of Greater St. Louis since January 2014 and is Past President and currently serving as Chair of the Board.