The way we invest today is stuck in the past. The current universal standard for portfolio design is called Modern Portfolio Theory (MPT), an approach introduced to the market in 1952. MPT creates portfolios that are customized to match the risk tolerance of each investor via asset allocation methods and then embraces a buy-and-hold portfolio management strategy.
A problem exists in that while markets have changed substantially since the 1950’s - see the chart at right - MPT methods have barely changed at all. As a result, investors are given “static” portfolio to try to cope with modern “dynamic” markets and they neither enable investors to take full advantage positive market potential nor to protect them from significant losses.
Here are just a few reasons why change in how we invest is needed; and fast:
1. A Subjective Portfolio Goal. MPT dictates that portfolios be designed to match the risk profile of each investor. The problem is that determining risk tolerance is a massively subjective process filled with error-prone human judgments. Yet, a mistake here can affect an investor's entire financial future.
2. Not a Comprehensive Theory of Investing. MPT uses scientific methods to match an investor’s risk tolerance level with an optimal portfolio asset allocation. That’s it. But successful investing requires far more than this. A more effective theory of investing would include guidance on how to manage a portfolio on an ongoing basis, what types of investments to buy and when to make profitable trades. MPT does none of this. So when experts say that the way we invest today is based on scientific methods, they are simply wrong.
3. No Market Sensitivity. MPT embraces a buy-and-hold portfolio management methodology. This means that they are not sensitive to changes in the economic environment and to market price movements. As a result, the value of MPT portfolios drifts up and down with the tides of the market with no rules for either taking profits or avoiding losses. This is a major problem with how we invest today.
4. Human Error Potential. The MPT portfolio design process is rife with human judgments making investing today more of an "art" than a "science". As a result, the effectiveness of a portfolio is too dependent on the advisor / artist chosen to create it. The “human error” risk element in portfolio development today is a huge and unacceptable problem.
5. MPT Fosters Dependence. It is difficult for the average investor to understand and implement MPT methods. Understanding and using such theories as the Capital Asset Pricing Model and the MPT Efficient Frontier is not something the public is able to do on their own. As a result, people with money to invest see little option but to entrust their financial futures to advisors who are also salespeople and simply hope for the best. Using today’s investing methods people have lost control of their financial futures. This is a problem
These problems and others that result from the exclusive use of the six+ decades-old MPT portfolio model are keeping millions of potential investors on the sidelines of the market in fear of an investing process that they don’t understand and that creates portfolios that produce mediocre returns with excessive risk. To bring these people into the market and improve the experience of those in the market, change is not optional.
The Change Needed
To evolve the world of investing into the 21st Century a new approach is needed; one that is simple to understand, produces higher returns than MPT portfolios with less risk and that provides absolute protection from market crashes. This is what the NAOI has developed in Dynamic Investment Theory (DIT) that is introduced on the next Slide.
The chart below shows that MPT was created when markets were a far less volatile place than they are today and that DIT was designed specifically to work in modern markets.