Modern portfolio theory (MPT) has become the whipping boy in recent years, and rightly so. Too many investors and financial advisors put it on a pedestal and assumed it had powers it could never achieve. Couple that with a global financial crisis and you have the groundwork for disappointment.
Like every theory, MPT is flawed and makes simplifying assumptions about the real world. That’s the nature of theories. But while it’s easy to pick apart MPT, assumption by assumption, at its core is a simple but effective foundation for investing. The fact that the historical record offers support for MPT-inspired real-world portfolios sweetens the deal. That’s not always obvious in a world that favors looking at one market at a time, or emphasizing the short term. But a careful look at how MPT performs over time suggests there’s value here.