Is It Possible To Build A Perfect Portfolio? (Modern Portfolio Theory Explained)

Every Investor wants to own a perfect investment that provides them high returns but low risk. People spend a lot of time coming up with methods to craft such optimal portfolios. In this video, we explore the most popular one - Modern Portfolio Theory (MPT) - developed in the 1950s by economist Harry Markowitz, who won a Nobel prize for it. We will delve into the concept of diversification, the balance between risk and return, and the efficient frontier to understand how investors can construct portfolios that maximize returns for any given level of risk.

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🛎️Disclaimer: Some of the links above are affiliate links, where I earn a small commission from your purchases at no additional cost to you. The content of the videos is for educational & entertainment purposes only and merely my opinions. I am not a financial adviser. All investments involve some risk, and there is no guarantee that you will succeed. To make the best financial decisions that suit your own needs, you must conduct your own research and seek the advice of a licensed financial adviser if necessary.

Chapters
00:00 Intro
01:15 Modern Portfolio Theory
02:43 Ray Dalio on How MPT works
03:51 Harry Markowitz
04:34 Markowitz's aha moment
06:17 Efficient Frontier
07:11 Harry Markowitz Career
08:41 Criticism of MPT
11:48 Markowitz's personal portfolio
13:12 Can we use MPT?

[truenorthhousedesign]

Thanks again Irene, I really do enjoy your fact -filled, and fast paced explanations of all things financial. It requires me to challenge my current prejudices and strategies. Much appreciated. Cheers

[Bluffalo-ep]

Yet another high quality video, thanks Irene :)

[tahaharrif]

I really aprreciate the effort u did in this video. GREAT WORK, love from morrocco <3

[OverRandomGamer]

Hey! I'm new to the Chanel. The content looks fantastic so far.

If you haven't already, you might consider making a video that explains volatility decay and how diversification reduces that rate of decay. It's a very similar concept to this video, but it gives another type of insight/perspective.

Here are some things you might consider having in the video:

An imaginary investment where our outcomes are like flipping a coin where heads returns +90% and tails returns -50%. It seems like a good option to start, but because of the multiplicative nature or returns it loses money over time.

Another way of looking at this is the arithmetic mean is positive, while the geometric mean is negative.

The first time we make that investment, the arithmetic mean is our expected return, but for each additional time we make that investment, our actual expected return gets closer to the geometric mean.

You can think that over time out expected return decays from the arithmetic mean to the geometric mean. Another word for that decay is volatility decay. Why is it volatility decay? Because when you measure the speed of that decay the formula requires us to know the variance (volatility) of our expected returns.

From here you could get into detail about diversification. Many people think it lowers risk, or increases expected returns, but what it really does is decrease the volatility, and thus the rate of decay from the arithmetic mean.

If we had a portfolio with 2 uncorrelated assets with an expected return of 10%, if both get that 10% we see a return of 10% (not 20 like some people might expect).

You could get into the math about how the variance of 2 events would equal the sum of the events variance.

Then you could talk about co variance. Realistically, most investments have some correlation (beta) this will reduce the effectiveness of the diversification so the variance will really be the same as the sum of the variance of both variables - their covariance.

Another thing people should think about here is that diversification into underperforming assets does not necessarily create enough of a benefit. For years I advised against debt based investments because while there variance is lower and it does decrease the variance of the over all portfolio, the expected return of other investments even after volatility decay had greater expected returns.

Anyway, I'd love to see what kind of video you might put together about this. If you wanted a click bait title you could do something like "this one metric could destroy your investment accounts unless you do this to take care of it." And have a picture of a shocked expression in the thumbnail and maybe a chart like this 📉.

If you have any questions about the math or want to talk about it with someone, feel free to reach out.

[talha-raja]

I believe you summarized it quite well. It's diversification against ignorance at the end of the day to lower the risks.
Even though I know historically S&P500 will outperform Global shares, I would still go with Global shares to minimise risk even if it underperforms.

[walkingtofi]

Great history lesson. Well researched!