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me and my money

Harry Markowitz won a Nobel Prize in Economics and became known as the father of Modern Portfolio Theory (MPT) in the years following the publication of his seminal 1952 paper, Portfolio Selection. Now nearly 92 years old, Mr. Markowitz is as busy as ever writing books on portfolio management, providing consulting services to the investment industry and looking after his multimillion-dollar portfolio.

The Globe and Mail talked to the legendary Mr. Markowitz about his contributions to the investment field, how he is investing his own portfolio and his top recommendations to investors.

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How might Modern Portfolio Theory be summed up?

I may end up oversimplifying and leaving some things out in a quick summary, but here goes. Prior to MPT, investors focused mostly on maximizing returns through stock-picking techniques. MPT expanded the focus to include the variances and co-variances of individual stocks, and it said that diversifying with inversely correlated assets lowered portfolio volatility and risk. The portfolios that minimized risk for a given level of return – or maximized return for a given level of risk – were on the “efficient frontier” curve and should be chosen by investors according to their preferred combination of risk and return. Then, as their chosen asset mix changed over time due to market trends, investors should rebalance by selling assets that appreciated the most and buying assets that lagged the most.

What about those who say MPT doesn’t work during financial crises and market crashes like in 2008?

Risk-averse investors who had Treasury bonds and gold bullion in their portfolios still performed well in 2008. While correlations between stocks may have increased, the inverse correlation of stock markets with short-term government bonds and gold held up and offset the plunge in stocks. Investors who kept portfolio risk under control though rebalancing would have also had a less stressful time.

Where are you invested these days?

In my financial portfolio, I have very few bonds and mostly stocks. Some people might say that is too risky especially for an old person like me. But I have non-financial assets that provide diversification. First, I have a lot of funds tied up in real estate, consisting of a principal residence, vacation properties and condo rentals. Second, my teacher’s pension and social security payments can be viewed as bond-like in that they provide a secure income for as long as I live. And even if my stocks were to take a big hit, there would still be lots of money left over in my stock portfolio. I may get back into bonds down the road but I would need their yields to increase to 4 per cent to make this an attractive option.

What stocks do you hold?

One-third of my stock holdings are in an ETF [exchange-traded fund] that tracks small-cap stocks and one-third is in an ETF that tracks emerging markets. This is the passive and diversified part. Rounding out my equity holdings is the active part: the one-third in several big-cap, construction-related stocks: Weyerhaeuser, Corning, Caterpillar, 3M, and United Technologies.

Why construction stocks?

I purchased them in 2017 after hurricanes and tornadoes hit Puerto Rico, Florida and Texas. I believed that the rebuilding effort would be substantial and benefit construction companies. There are also huge needs to upgrade and build new infrastructure in the United States and other countries.

What would be your main recommendations to individual investors?

In a word: diversify. Spread your risks over several asset classes whose returns are not highly correlated. Then rebalance back to your target asset allocation – don’t get caught up in chasing returns or hot stock tips. Past performance is not indicative of future returns. When the lady behind the counter at the bagel shop asks me how she should invest, I say put half in a savings account and half in a low-cost ETF tracking the stock market. The more rigorous version of MPT, where matrices of variances and correlations are calculated, is for professionals and investors with the time and resources to take on such a workload. Also, people with special knowledge, inferences, opportunities or investing skills, like Warren Buffett, can get by with less diversification and a more active approach.

This interview has been edited and condensed.

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