If you are the typical investor you probably hold a portfolio designed using Modern Portfolio Theory (MPT) methods. The MPT approach dictates the use of asset allocation, mainly between stocks and bonds, to match the risk tolerance level of the holder. The problem is that by using such an approach MPT portfolios neither enable you to take full advantage of positive market returns potential or nor protect you from market downturns.
Why? Because MPT also dictates that once a portfolio is created it should be bought and held for the long term making it a “static” investment trying to cope with today's “dynamic” markets. As a result of this disconnect, most of the investing public today holds portfolios that produce paltry returns over the long-run while leaving them vulnerable to significant market downturns and loss of wealth such as we saw in 2008-2009 when millions of people lost up to 50% of their wealth by holding MPT portfolios.
The MPT “Settled Science” Roadblock
Why do we, as individual investors, accept such flawed portfolios? The reason is because MPT methods are seen today by the financial services industry as the “settled science” approach for portfolio design and seemingly not open to debate. No one in the financial services industry dares question the use of MPT methods, probably because they serve as a basis for very profitable business models. And individuals today are so under-educated in the ways of investing that they simply accept what self-proclaimed financial “experts” recommend to them without question. So the MPT approach thrives even in the face of empirical evidence that it is a severely flawed portfolio design approach.
It’s Time for Change
This unquestioning reliance on MPT portfolio design needs to end. Markets have changed significantly since 1952 when MPT was introduced. But the methods we use to cope with them have barely changed at all – and they no longer work. Fortunately the MPT problem is not hard to fix. On the site that hosts this blog you can seen how it is done. I will summarize the solution below:
MPT Risk Reduction Factors
Let's start by examining how MPT uses two factors to reduce risk. They are as follows:
1. Company Diversification. This is accomplished by the use of mutual funds and ETFs that enable investors to own stocks of dozens or even hundreds of companies with one purchase
2. Asset Allocation. This is accomplished by dividing portfolio money among different asset classes that tend to move in opposite directions in any market condition - such as stocks and bonds.
Both of these factors reduce risk – but neither enhances returns. So MPT portfolios sacrifice returns potential for risk reduction. And this is a problem.
Here’s the Fix
On this Web site you will learn about a new approach to portfolio design called NAOI Dynamic Investment Theory. It creates Dynamic Investments that use the two MPT risk reduction factors described above, but adds one more as follows:
3. Time-Diversification. This factor enables the portfolio to change the equities it holds based on empirical observation of market movements. By striving to identify and buy only ETFs that are moving up in price and selling or avoiding those that are moving down, time-diversification provides to the portfolio both risk reduction AND return enhancement.
Time Diversification Implementation
The concept of improving portfolio performance by adding time-diversity is sound. But the implementation is not as clear-cut as company diversification or asset allocation. Fortunately the NAOI has developed a method for adding time-diversity to a portfolio in a simple and effective manner.
Dynamic Investment Theory – discussed on this site - describes how to build dynamic portfolios / investments that periodically and automatically sample market trends in order to buy only equities (ETFs in this case) that are moving up in price in current market conditions and to sell or avoid ETFs that are moving down in price. The goal of NAOI Dynamic Investments is to own only “winning” investments at all times and as a result their returns are free to soar. This is in direct contrast to MPT portfolios that are designed to, at all times, own both winning AND losing investments via asset allocation. By doing so their returns potential is severely constrained.
Unleashing the Returns Potential of Portfolios
Extensive NAOI research and testing show that with the addition of time-diversification to a portfolio / investment it is able to regularly produce annual return rates of +20% and higher with minimal risk. Portfolios designed based on NAOI Dynamic Investment Theory have been shown to produce returns that are multiple times higher than portfolios designed based on Modern Portfolio Theory - and with less risk!
Advancing the Field of Investing
The addition of Time-Diversification to a portfolio is a major step forward in the evolution of investing. Finally investors can own the dynamic portfolios that are needed to cope with, and taking full advantage of, the positive returns potential of modern dynamic markets.
The site that hosts this blog gives you full details on this major step forward in the evolution of investing. Time-diversification is a key component to the future of investing.