Harry Markowitz meets the Efficient Frontier - and blinks

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Harry Markowitz meets the Efficient Frontier - and blinks

Post by Browser » Sat Jan 25, 2014 11:03 pm

Jason Zweig tells a story about Harry Markowitz, who developed the statistical model of the efficient frontier and won the Nobel Prize for it.
Mr. Markowitz was working at the RAND Corporation and trying to figure out how to allocate his retirement account. He knew what he should do: “I should have computed the historical co-variances of the asset classes and drawn an efficient frontier.” (That’s efficient-market talk for draining as much risk as possible out of his portfolio.)

But, he said, “I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.”
http://www.nytimes.com/2007/09/29/busin ... =rss&_r=1&

Harry exemplifies the truth of what Yogi Berra once observed: "In theory there is no difference between theory and practice, but in practice there is."
We don't know where we are, or where we're going -- but we're making good time.

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nedsaid
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Re: Harry Markowitz meets the Efficient Frontier - and blink

Post by nedsaid » Sat Jan 25, 2014 11:18 pm

The math geeks and the engineers on this forum sometimes make investing look more precise than it really is. The story about Dr. Markowitz illustrates this perfectly.

I certainly find the efficient frontiers, the graphs, the ratios, the model portfolios, the monte carlo similations and all that to be useful in constructing a portfolio. I just consider it to be a rough guide. For example, the correlations between asset classes and the standard deviations of asset classes change all the time. Even "stay the course" Vanguard has changed the asset allocations and glide paths of its Target Date Retirement Funds. So this stuff is a moving target.

Rather than follow the cookbook exactly, I have been more like a scratch cook. A dab of this, a dash of that. Hmmm, that looks good, I'll throw some of that in there. My portfolio has not precisely followed the recipe. So I don't feel so bad about not having a 100% scientific approach to investing.
A fool and his money are good for business.

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Re: Harry Markowitz meets the Efficient Frontier - and blink

Post by magician » Sun Jan 26, 2014 12:39 am

Don't read too much into that quote.

When I interviewed Dr. Markowitz, I asked him about this story. He said that he had a choice of two investments: stocks and bonds. Thus, every combination of those two is on the minimum variance frontier, and all of those at or above the global minimum variance portfolio is on the efficient frontier. He did, in fact, choose an efficient portfolio.
Simplify the complicated side; don't complify the simplicated side.

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Re: Harry Markowitz meets the Efficient Frontier - and blink

Post by Valuethinker » Sun Jan 26, 2014 11:10 am

magician wrote:Don't read too much into that quote.

When I interviewed Dr. Markowitz, I asked him about this story. He said that he had a choice of two investments: stocks and bonds. Thus, every combination of those two is on the minimum variance frontier, and all of those at or above the global minimum variance portfolio is on the efficient frontier. He did, in fact, choose an efficient portfolio.
As I understand it, academics in those days had a choice of 2 funds: what is the TIAA annuity (general fund) now, and the TIAA stock fund. Hence the bond-equity split. The former fund behaving in most ways like a short to intermediate term bond fund.

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Re: Harry Markowitz meets the Efficient Frontier - and blink

Post by Browser » Sun Jan 26, 2014 11:34 am

I guess he didn't know much about human capital. He should have been 100% invested in stocks, not 50/50. But his emotions took over I guess.
We don't know where we are, or where we're going -- but we're making good time.

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