Saluting the Father of Modern Finance

When asked who they would put in the pantheon of late, great, investing trailblazers, most folks initially think of the great stock pickers. Names like Ben Graham, Sir John Templeton and Philip Fisher. But no list would be complete without a certain academic whose great insight was that stock-picking is overrated: Harry M. Markowitz, who passed away last week at age 95. As the Nobel-winning father of Modern Portfolio Theory, he is the one we must all thank for the knowledge that asset allocation—not which stocks you own—is responsible for the majority of investment returns. If you have a broad diverse stock portfolio today, his work is a big reason why.

In a world where index funds are ubiquitous and everyone watches “the market,” it might seem weird to hear that it was once revolutionary to assign risk and return characteristics to entire asset classes as a whole. But in the early 1950s, when Markowitz published his groundbreaking paper, “Portfolio Selection,” it was. People bought the stocks they thought would go up, and if those stocks didn’t go up, then the decision must have been wrong. There was no concept of yah, but it did better than other securities, so it helped relative returns. As one Markowitz retrospective published on Bloomberg today explained: “If a trustee bought a stock that went down, the trustee could be liable to make up the loss. The trustee couldn’t argue that the overall portfolio of stocks bought had outperformed bonds, any more than a person who caused an automobile accident could argue that he or she had avoided lots of other accidents and had a better-than-average driving safety record.”^[i] But as other researchers built off Markowitz’s work, the concept of asset allocation—blending stocks, bonds and other securities based on their expected long-term risk and return—went mainstream.

There are numerous practical applications today, from the rise of index funds to the simplification of retirement planning. Today we will focus on one of the most encouraging: Investing successfully doesn’t require finding the needle in the haystack. Nor does it require that every stock you own goes up. Rather, it is all about having the right asset allocation for you. That is, determining the long-term returns you need to reach your financial goals and needs over your entire investment time horizon (the length of time your portfolio must be working for you) and balancing that with the level of risk that matches your cash flow needs, time horizon, comfort with volatility and general personal circumstances. Once you have a blend of stocks, bonds and other securities that fits you, success is generally about being diversified and disciplined over the long haul. Not set it and forget it, but focusing on whether your portfolio, as a whole, is acting like you would expect it to act in a given market environment—and tweaking as needed to keep it on track.

Markowitz’s work is a reminder that the performance of the entire portfolio matters more than any one of its holdings. There will always be stocks that lead the market and stocks that trail it, and the leaders and laggards will change places often without warning. If a portfolio is adequately diversified—with broad sector and geographic exposure as well as a sufficient number of stocks—then it will likely own some of each. If every stock in your portfolio were beating the market, then that would mean you have large blind spots that will likely work against you when other sectors or industries have their day in the sun. By focusing on the totality of your portfolio, rather than getting hung up on one or two disappointing or blistering stocks, you can see things more clearly and reduce the risk of error. 

None of this sounds like revolutionary, earth-shattering stuff now. It might be easy to dismiss as intuitive, boring diversification. But it is an important reminder at a time when AI hype is everywhere and pundits are bemoaning low market breadth. Headlines can make it hard to remember to breathe and let your asset allocation do the heavy lifting. Timeless, seemingly boring old concepts are an underrated antidote to hype and handwringing—a dose of sanity in all the madness.

So here’s to the father of modern finance and all of the sanity his work inspired. Here’s to asset allocation, diversification and the twin powers of market-like returns and compound growth.