Needed: A 21st Century Theory of Investing
From the founding of the NAOI in 1997 the NAOI has taught our students how to create portfolios using industry standard Modern Portfolio Theory (MPT) methods. Yet, in 2008-2009 when the stock market crashed, we watched in dismay as these portfolios crashed along with the market. In 2010 when the crash was finally over, I, Leland Hevner, President of the NAOI, made the difficult decision to pause all of our extensive education activities.
I had to face the harsh reality that MPT portfolio design methods (introduced to the market in the 1950’s) simply could not cope with modern markets. They produced “static”, buy-and-hold portfolios in today’s “dynamic” markets and, as a result, MPT-based portfolios neither enabled investors to take full advantage of market price uptrends nor protected them from significant price downtrends.
With this realization I refocused NAOI resources from Education to Research and Development in order to find and develop a new approach to portfolio design and investing in general that could take maximum advantage of today’s dynamic markets, both stock uptrends AND stock downtrends. On this page I describe how, following a multi-year effort, we found it in the form of Dynamic Investment Theory.
The Goals for a New Approach to Investing
As we started our research effort I was determined to find a new approach to investing that is designed to meet the needs of the investing public. So our first task was to interview average people with money to invest. Fortunately the NAOI has access to hundreds of individual investors who are either NAOI students or NAOI members. They represented the comprehensive cross-section of the investing public needed to define our development goals. We asked them what they wanted and needed to become confident investors and willing to enter the equity markets without fear. In summary, they told us that the following features of a new approach were essential:
A greatly simplified approach to investing - one that could be explained in less than 10 minutes
Higher returns with less risk than the MPT portfolios in all market conditions
Absolute protection from market crashes
Less dependence on third parties to make portfolio design and trade decisions
Make available a simple and viable “Do It Yourself” investing option using an online broker
We immediately saw that MPT met none of these goals. So we started our research with a blank slate; as if MPT had never existed.
The Use of Data Analysis and Scientific Methods
From the start it was obvious that the only way to meet these goals was to develop an investing approach in which trade decisions are made based on observations and analysis of historical market data instead of being based on subjective human judgments which are the source of so much that is wrong investing today. To meet the goals set for us by the investing public, we needed an approach based on scientific methods.
Our first task was to find patterns in historical data that had proven predictive value for future equity price movements. Based on significant research we found the data set that we needed in the form of equity price trends. Historical data analysis showed to us that the prices of asset classes and markets / market segments are cyclical and that the prices of different asset types and different market segments move up and down at different times as illustrated below.
Based on this observation and in keeping with scientific methods we developed the following Premise:
A premise is an assumption that something is true and is the first step toward developing a theory, as discussed next.
The Creation of a Theory
Continuing with our scientific methodology, the next task was to test our Premise. For this purpose we created and tested dozens of prototype designs. We found one design that showed our premise to have a high probability of being true. We called this new investment type NAOI Dynamic Investments (DIs). They are discussed at this link.
Based on positive testing results, we transformed our Premise to a Theory. We called this theory Dynamic Investment Theory (DIT). It sets the logic and defines the rules for creating Dynamic Investments that meet every goal set for us by the public and more. With the discovery and development of DIT and DIs, the world of investing changed at a fundamental level; and for the better.
A Game-Changing Discovery
The NAOI understands that the observation that equity prices are cyclical and that uncorrelated assets move up and down at different times is not a new discovery. Market cycles and momentum investing have been studied and used for years.
The significant breakthrough that the NAOI has made is the creation of a simple investment type that enables the investing public to easily take advantage of the predictive information available in market cycles. This is not insignificant. The high returns produce by Dynamic Investments are typically found only in the dark realm of hedge-funds. Via Dynamic Investment Theory, the NAOI has brought these high returns, without excessive risk, directly to the average investor in a simple, easy to understand and user-friendly manner.
Benefits for Investors and the Financial Industry
NAOI students who have been field-testing Dynamic Investments for over two years tell us that DIT is the approach to investing they need to confidently enter the market without fear. As a result of this input and years of testing this approach, the NAOI is now including incorporating it into our extensive investor education network and we expect the demand for its use to grow. Financial organization who learn about and plan for the demand for Dynamic Investments will capture this new influx of clients and gain a massive competitive advantage in a crowded market. The NAOI can help in this effort via a consulting agreement as discussed here.
Learn more about Dynamic Investments at this link.