Kudos to the lazy portfolio (aka Modern Portfolio Theory)

Paul Farrell has written a wonderful article discussing the immense success many published Lazy Man's portfolio's have had compared to their market indeces. You can find the article here at Market Watch.

Farrell compares quite a few of the simple passive investment portfolios recommended by some of the most well known advocates of MPT. In virtually all cases the portfolios have beaten the S&P 500 over the prior 5 year period. Virtually all also beat the s&p 500 index for the three year period and half beat the one year index.

I strongly recommend the article. It's a great glimpse into the power and benefit of a passive indexing strategy using MPT.

A few quick comments on the article:

1. The S&P 500, although well known is an inappropriate comparitor - most of the portfolios are diversfied outside of the s&p 500 - it's comparing apples and oranges.
2. Some of the portfolios selected from different writers are hardly their high performing portfolios (Bernstein is a good example).
3. One year returns, although interesting, are especially meaningless when analyzing index investing strategies. 30 year regressions would be much more interesting and include more varied markets.

Anyway, try the articles, it's a great way to examine the actual undertakings of low cost index based strategies using MPT (modern portfolio theory).

Regards, makingourway

Asset Allocation: How diversification improves portfolio performance

I'm reading Rick Ferri's All About Asset Allocation. Great book. More how to and less academic than Bernstein's book. I recommend reading the Four Pillars first. It has a stronger theoretical foundation.

In chapter 2 Ferri discusses risk and return. One of the interesting points he raises - something I hadn't read before, is the relationship between volatility, simple average return and compound return.

Volatility represents the amount of up and down an asset class experiences; e.g. historically, in one year, 86% of the time (i.e. usually) the asset class goes up to 20% or down to 7%.

The simple average return is the average of returns for each year; e.g. over 5 years the average return for each year was 10%.

The compound return is different. It factors the impact of the prior year's return into the results of the current year. So a highly volative stock might drop 20% in year one from 10 down to 8. The following year it goes up 10%. The new value is 8 times 10% or $8.80. Whereas the simple average would have calculated the value as $9.00. Over time, the numbers can drift apart quite a bit.

An effective asset allocation plan which invests in low correlating assets helps insure that only some assets go down, while others go up. The end result of an effective allocation strategy is reduced volatility while maintaining a high average rate of return.

As I read on, I'll share some of the thoughts I learned. I for one, am interested in the question "how do you allocate to reduce volatility while maintaining a high rate of return."

Regards,
makingourway

Makingourway's bookshelf

I've been thinking about putting up a bookshelf of recommended reading focussing on investment planning, personal finance and financial history. Are there any other topics anyone would recommend?

Can anyone recommend well done bookshelf examples?

I have about 20 books to list - examples would be:
Bernstein's Four Pillars of Investing
Ferri's All About Asset Allocation

Etc...

Regards, makingourway