MPT - Conclusions

This article has presented a rapid overview of modern portfolio theory. How much of it you can actually use depends on your own investment philosophy. Everybody can benefit from the first two points:

The short term dangers of volatility are real; even an excellent long term investment can be a disaster for you if your time horizon is short.
Diversification reduces volatility more efficiently than most people understand: the volatility of a diversified portfolio is less than the average of the volatilities of its component parts.

If you're a dedicated stock picker then that's probably as far as you'll go. But if you lean toward mutual funds, you can use the third point:

A scientific way to attain a diversified portfolio is by using simple tools to choose a small number of low cost index funds. The obvious starting point would be a total stock market fund, possibly with a smaller portion (preferably within a tax-sheltered account like an IRA) in a small value fund.

One other point: MPT critics like to emphasize a few occasions where people have stretched theory way beyond common sense and lost a ton of money. But that shouldn't distract you from the "core" message of MPT, that volatility can be planned for, and that diversification and index investing let average people participate intelligently in the market.

Article Contents
MPT Introduction
Volatility and Time
Efficient Frontier
Sharpe Ratio
Build a Portfolio
Index Investing
CAPM, Beta
Alpha, R-Squared
Three Factor Model
Insurance Analogy
Books & Links

Article Contents
Index Funds Article
CAPM Calculator
Market Simulator


home  |  article  |  glossary  |  calculator  |  about us  |  books