Why a 70-Year Old Theory Still Holds the Key to Smart Investing
Harry Markowitz’s Nobel-prize-winning Modern Portfolio Theory still holds up well in the age of cryptocurrencies and meme stocks
An important milestone passed almost unnoticed last month when Modern Portfolio Theory, or MPT, turned seventy. It was in March 1952 when Harry Markowitz published his seminal paper, Portfolio Selection, in the prestigious Journal of Finance. Those fifteen pages not only helped Markowitz win a Nobel Prize in Economics, but also helped to shape an industry, and the way we invest today. If you have a stock investing app offering Exchange Traded Funds (ETFs), you have Markowitz to thank.
While it’s commonplace to think of constructing a diversified portfolio, that wasn’t always the conventional wisdom. It was Harry Markowitz who provided a theory and a process to the notion of diversification. My co-author, MIT Sloan Finance Professor Andrew Lo, and I had the pleasure of interviewing Markowitz for our book, In Pursuit of the Perfect Portfolio, and he shared that Pre-MPT there was no “notion that you should have a theory about what makes a well-diversified portfolio and what is the trade-off between risk and return. It’s surprising that the human race went so long to leave me to discover that.”
As we account in our book, how Markowitz became interested in researching in the area of investments was pure luck. Markowitz was working toward his PhD in economics at the University of Chicago but was struggling to find a dissertation topic. He went to his doctoral adviser, Jacob Marschak, who was busy when Markowitz arrived, so Markowitz waited in Marschak’s anteroom. There was also a stockbroker waiting for Marschak. While they waited, the two chatted about Markowitz’s dissertation dilemma. After Marschak finally invited him in, Markowitz said to Marschak, “The guy out there says I should do a dissertation on the stock market. What do you think?” And of course, the rest is history. Later Markowitz fondly acknowledged that this was the best advice he ever received from a stockbroker.