The flaws with the most widely used approach to investing

Standard asset allocation practice (“strategic asset allocation”) is based on modern portfolio theory.

Modern portfolio theory is derived from a research paper written by Harry Markowitz.

In his paper, Markowitz describes two stages.

“The first stage starts with observation and experience and ends with beliefs about the future performances of available securities.

The second stage starts with the relevant beliefs about future performances and ends with the choice of the portfolio. This paper is concerned with the second stage.”

Portfolio Selection, 1952

Unfortunately the standard practice in the strategic asset approach assumes investment performance over the last 100+ years will be the same on average in the next 100+ years.

But research shows that investing is like life … it can be complicated…for example…

Analysis shows investing in stocks works best in time frames typically of 7-10 years.

AND, most importantly research also shows you have to be able to make adjustments to your investing approach in order to achieve above average performance.


In Robert J. Shiller’s research on investing in stocks he found that over the long-term (which he defined as 10 years), US stock returns were higher for stocks with lower starting valuations and vice versa.

Crestmont Research illustrates this with their chart:


In their investing research supporting their paper “When Diversification Fails,” T Rowe Price fund managers found:

One of the most vexing problems in investment management is that diversification seems to disappear when investors need it the most. We surmise that many investors still do not fully appreciate the impact of extreme correlations on portfolio efficiency—in particular, on exposure to loss. “

So, what’s the problem with strategic asset allocation? When losses grow, the gain required to make up the loss grows exponentially.

-Three Principles-

The first principle is that investing is a sequential dynamic process that changes with time.

The second principle is to grow our wealth over time. Period.

A strategy that reduces the portfolio’s risk increases the portfolio’s Compound Annual Growth Rate (CAGR) over time. This is the third principle.