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Top Five Investing Articles for Individual Investors Read in 2019

09 Monday Dec 2019

Posted by wmosconi in asset allocation, Average Returns, behavioral finance, beta, bond yields, confirmation bias, correlation, correlation coefficient, economics, finance theory, financial advice, Financial Advisor, financial advisor fees, financial advisory fees, financial goals, financial markets, Financial Media, Financial News, financial planning, financial services industry, gross returns, historical returns, Individual Investing, individual investors, investing, investing advice, investing information, investing tips, investment advice, investment advisory fees, investments, market timing, personal finance, portfolio, reasonable fees, reasonable fees for financial advisor, reasonable fees for investment advice, reasonable financial advisor fees, risk, risk tolerance, risks of stocks, S&P 500, S&P 500 historical returns, S&P 500 Index, speculation, standard deviation, statistics, stock market, Stock Market Returns, stock prices, stocks, time series, time series data, volatility, Warren Buffett, yield, yield curve, yield curve inversion

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As the end of 2019 looms, I wanted to share a recap of the five most viewed articles I have written over the past year.  The list is in descending order of overall views.  Additionally, I have included the top viewed article of all time on my investing blog.  Individual investors have consistently been coming back to that one article.

1. Before You Take Any Investment, Advice Consider the Source – Version 2.0

Here is a link to the article:

https://latticeworkwealth.com/2019/09/18/investment-advice-cognitive-bias/

This article discusses the fact that even financial professionals have cognitive biases, not just individual investors.  I include myself in the discussion, talk about Warren Buffett, and also give some context around financial market history to understand how and why financial professionals fall victim to these cognitive biases.

2.  How to Become a Successful Long-Term Investor – Understanding Stock Market Returns – 1 of 3

Here is a link to the article:

https://latticeworkwealth.com/2019/09/23/successful-long-term-investing/

It is paramount to remember that you need to understand at least some of the history of stock market returns prior to investing one dollar in stocks.  Without that understanding, you unknowingly set yourself up for constant failure throughout your investing career.

3.  How to Become a Successful Long-Term Investor – Understanding Risk – 2 of 3

Here is a link to the article:

https://latticeworkwealth.com/2019/09/25/successful-long-term-investor-risk/

This second article in the series talks about how to assess your risk for stocks by incorporating what the past history of stock market returns has been.  If you know about the past, you can better prepare yourself for the future and develop a more accurate risk tolerance that will guide you to investing in the proper portfolios of stocks, bonds, cash, and other assets.

4.  Breakthrough Drugs, Anecdotes, and Statistics – Statistics and Time Series Data – 2 of 3

Here is a link to the article:

https://latticeworkwealth.com/2019/11/20/breakthrough-drugs-statistics-and-anecdotes-time-series-statistics/

I go into detail, without getting too granular and focusing on math, about why statistics and time series data can be misused by even financial market professionals.  Additionally, you need to be aware of some of the presentations, articles, and comments that financial professionals use.  If they make these errors, you will be able to take their comments “with a grain of salt”.

5.  Breakthrough Drugs, Anecdotes, and Statistics – Introduction – 1 of 3

Here is a link to the article:

https://latticeworkwealth.com/2019/11/11/breakthrough-drugs-statistics-and-anecdotes-investing/

I kick off this important discussion about the misleading and/or misuse of statistics by the financial media sometimes with an example of the testing done on new drugs.  Once you understand why the FDA includes so many people in its drug trials, you can utilize that thought process when you are bombarded with information from the print and television financial media.  Oftentimes, the statistics cited are truly just anecdotal and offer you absolutely no guidance on how to invest.

                                       Top of All Time

Are Your Financial Advisor’s Fees Reasonable?  Here is a Unique Way to Look at What Clients Pay For

Here is a link to the article:

https://latticeworkwealth.com/2013/08/07/are-your-financial-advisors-fees-reasonable-here-is-a-unique-way-to-look-at-what-clients-pay-for/

This article gets the most views and is quite possibly the most controversial.  Individual investors compliment me on its contents while Financial Advisors have lots of complaints.  Keep in mind that my overall goal with this investing blog is to provide individual investors with information that can be used.  Many times though, the information is something that some in the financial industry would rather not talk about.

The basic premise is to remember that, when it comes to investing fees, you need to start with the realization that you have the money going into your investment portfolio to begin with.  Your first option would be to simply keep it in a checking or savings account.  It is very common to be charged a financial advisory fee based upon the total amount in your brokerage account and the most common is 1%.  For example, if you have $250,000 in all, your annual fee would be $2,500 ($250,000 * 1%).

But at the end of the day, the value provided by your investment advisory is how much your brokerage account will grow in the absence of what you can already do yourself.  Essentially you divide your fee by the increase in your brokerage account that year.  Going back to the same example, if your account increases by $20,000 during the year, your actual annual fee based upon the value of the advice you receive is 12.5% ($2,500 divided by $20,000).  And yes, this way of looking at investing fees is unique and doesn’t always sit well with some financial professionals.

In summary and in reference to the entire list, I hope you enjoy this list of articles from the past year.  If you have any investing topics that would be beneficial to cover in 2020, please feel free to leave the suggestions in the comments.

How to Become a Successful Long-Term Investor – Part 2 of 3 – Understanding and Reducing Risk

25 Wednesday Sep 2019

Posted by wmosconi in asset allocation, behavioral finance, Consumer Finance, Education, finance, finance theory, financial advice, Financial Advisor, financial goals, financial markets, Financial Media, Financial News, financial planning, financial services industry, Geometric Returns, historical returns, Individual Investing, individual investors, investing, investing advice, investing tips, investment advice, investments, math, Modern Portfolio Theory, MPT, personal finance, portfolio, risk, risk tolerance, risks of stocks, S&P 500, S&P 500 historical returns, S&P 500 Index, standard deviation, statistics, stock market, Stock Market Returns, Stock Market Valuation, stock prices, stocks, volatility

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academia, academics, behavioral finance, finance, financial, historical stock returns, invest, investing, investments, math, mathematics, Modern Portfolio Theory, MPT, performance, portfolio, portfolio management, S&P 500, S&P 500 historical returns, S&P 500 Index, standard deviation, statistics, stock market, stock returns, stocks, success, uncertainty

Another extremely important part of being a long-term investor is to understand the concept of risk.  Financial professionals define risk in a number of different ways, and we will examine some of those definitions.  The overarching goal is to look at risk from the standpoint of the volatility or dispersion of stock market returns.  Diversification of various investments in your portfolio is normally the way that most financial professionals discuss ways to manage the inevitable fluctuations in one’s investment portfolio.  However, there is another more intuitive way to reduce risk which will be the topic of this second part of this examination into becoming a successful long-term investor.

The first part of this series on long-term investing was a look back at the historical returns of the S&P 500 Index (including the reinvestment of dividends).  The S&P 500 Index will again be the proxy used to view the concept of risk.  If you have not had a chance to read the first part of the series, I would urge you to follow the link provided below.  Note that it is not a prerequisite to follow along with the discussion to come, but it would be helpful to better understand the exploration of risk in this article.

The link to part one of becoming a successful long-term investor is:

https://latticeworkwealth.com/2019/09/23/successful-long-term-investing/

But now we will turn our attention to risk.  Risk can be a kind of difficult or opaque concept that is discussed by financial professionals.  Most individual investors have a tough time following along.  Sometimes there is a lot of math and statistics included with the overview.  Although this information is helpful, we need to build up to that aspect.  However, there will be no detailed calculations utilized in this article that might muddy the waters further.  I believe it helps to take a graphical approach and then build up to what some individual investors consider the harder aspects of grasping risk.

Risk related to investing in stocks can be defined differently, but the general idea is that stocks do not go up or down in a straight line.  As discussed in depth in part one, the annual return of the S&P 500 Index jumps around by a large margin.  Most individual investors are surprised at seeing the wide variation.  Ultimately, the long-term historical average of the S&P 500 Index from 1957 to 2018 is 9.8%.  But rarely does the average annual return end up being anywhere near that number.

The first way I would like to look at risk within the context of long-term investing is to go back to our use of “buckets” of returns.  If you have not already read part one, I used “buckets” with ranges of 5% to see where stock returns fit in.  As it relates to risk, we are only going to look at the “bucket” that includes the historical average 7% to 12% and then either side of that “bucket” (2% to 7% and 12% to 17%).  Additionally, we will look at yearly stock returns and then annualized stock returns for three years, five years, and ten years.  Here is our first graph:

Returns on Either Side of Historical Average

The main takeaway from viewing this graph is that, as the length of time increases, more stock market returns for the S&P 500 Index group around the historical average for the index of 9.8%.  Remember that part one covered the useful information that, even though the historical average to be expected from investing in stocks is 9.8%, individual investors need to know that it can take long periods of time to see that historical average.  In fact, if we look only at one-year increments, approximately 33.9% of stock returns will fall into the range of 2% to 17%.    Or, if we use our yearly equivalent, stock market returns will only fall within that range 1 out of every 3 years.  When individual investors see this graph for the first time, they are usually shocked and somewhat nervous about investing in stocks.

The important thing to keep in mind is that as the length of time examined increased many more stock returns fall into this range.  The numbers are 65.0%, 67.1%, and 81.1%, for three years, five years, and ten years, respectively.  Converting those numbers to yearly equivalents we have about 6-7 years out of ten for three years and five years.  And, as one would intuitively suspect, the longest timeframe of ten years will have stock returns falling into the 2% to 17% range roughly 8 in every 10 years.  Now that still means that 20% to 35% of long-term returns fall outside of that range when considering all those time periods.  But I believe that it is certainly much more palatable for individual investors than looking at investing through the lens of only one-year increments.

Another aspect of risk is what would be termed downside protection.  Most individual investors are considered to be risk averse.  This term is just a fancy way of saying that the vast majority of investors need a lot more expected positive returns to compensate them for the prospect of losing large sums of money.  Essentially an easier way to look at this term is that most individual investors have asymmetric risk tolerances.  All that this means in general is that a 10% loss is much more painful than the pleasure of a 10% gain in the minds of most investors.  Think about yourself in these terms.  What would you consider the offset to be equal when it comes to losing and earning money in the stock market?  Would you need the prospect of a 15% positive return (or 20%, 25% and so forth) to offset the possibility of losing 10% of your money in any one year?  Let’s look at the breakdown of the number of years that investors will experience a loss.  To be consistent with my first post, I am going to use the “bucket” of -3% to 2% and work down from there.  Here is the graph:

Returns Less than 2%

There are 61 years of stock market returns from the S&P 500 Index for the period 1957 to 2018.  If we look at the category of 1 year, stock market returns were 2% or less 38.7% of the time (17 years out of 61 years).  However, if we move to five-year and ten-year annualized returns, there were no observations in the -3% to -8%, -8% to -13%, or less than -13% “buckets”.  When looking at losing money by investing in the stock market, a long-term focus and investment strategy will balance out very negative return years and your portfolio is less likely to be worth significantly less after five or ten years.  Of course, there are no guarantees and perfect foresight is something that we do not have.  However, I believe that looking carefully at the historical data shows why it is important to not be so discouraged by years when the stock market goes down and even stays down for longer than just one year.  Hopefully these figures do provide you with more fortitude to resist the instinct to sell stocks when the stock market takes a deep decline if your investment horizon and financial goals are many, many years out into the future.

The final concept I would like to cover is standard deviation.  The term standard deviation comes up more often than not either in discussions with financial professionals during client meetings or is used a lot in the financial media.  There are many times when even the professionals use the term and explain things incorrectly, but we will save that conversation for another post.  Standard deviation is a statistical term that really is a measure of how far away stock market returns are from the mean (i.e. the average).  It is a concept related to volatility or dispersion.  So, the higher the number is, the more likely it is that stock market returns will have a wide range of returns in any given year.  Let’s first take a look at a graph to put things into context.  Here it is:

Standard Deviation

The chart is striking in terms of how much the standard deviation decreases as the time period increases.  A couple things to note.  First, I do not want to confuse you with a great deal of math or statistical jargon and calculations.  My point is not to obscure the main idea.  Second, the 25-year and 50-year numbers are just included only to cover the entire period of 1957 to 2018 for the S&P 500 Index.  These periods of time are not of much use to individual investors to consider their tolerance for risk and the right investments to include in their portfolios.  And, as one of the most famous economists of the 20th century, John Maynard Keynes, quipped:  “In the long run, we are all dead”.  My only point is that discussion of how the stock market has performed over 25 years or longer is just not relevant to how most individuals think.  It is nice to know but not very useful from a practical perspective.

The main item of interest from the graph above of standard deviation is that you can “lower” the risk of your portfolio just by lengthening your time horizon to make investment decisions on buying or selling stock.  For example, the standard deviation goes down 46.9% (to 8.95% from 16.87%) between one-year returns and three-year annualized returns.  Why do I use “lower”?  Well, the risk of your portfolio will stay constant over time and focusing on longer periods of time will not decrease the volatility per se.  However, most financial professionals tell their clients to not worry about day-to-day fluctuations in the stock market.  Plus, most Financial Advisors tell their clients to not get too upset when reviewing quarterly brokerage statements.  This advice is very good indeed.  However, I urge you to lengthen the period of your concern about volatility in further out into time.  My general guideline to the individuals that I assist in building financial portfolios, setting a unique risk tolerance, and planning for financial goals is to view even one year as short term akin to examining your quarterly brokerage statement.

Why?  If you are in what is termed the “wealth accumulation” stage of life (e.g. saving for retirement), what occurs on a yearly basis is of no concern in the grand scheme of things.  The better investment strategy is to consider three years as short term, five years as medium term, and ten years as the long term.  I think that even retirees can benefit with this type of shift.  Now please do not get me wrong.  I am not advising that anyone make absolutely no changes to his/her investment portfolio for one-year increments.  Rather, annual returns in the stock market vary so widely that it can lead you astray from building a long-term investing strategy that you can stick to when stock market returns inevitably decline (sometimes precipitously and by a large margin).  Note that all the academic theories, especially Modern Portfolio Theory (MPT), were built using an assumption of a one-year holding period for stocks (also bonds, cash, and other investments).  Most individual investors do not fall into the one-year holding period.  Therefore, it does not make much sense to overly focus on such a short time period.

Of course, the next thought and/or comment that comes up is “what if the stock market is too high and I should sell to avoid the downturn?”.  I will not deny that this instinct is very real and will never go away for individual investors.  In fact, a good deal of financial media television coverage and news publications are devoted to advising people on this very topic every single day.   It is termed “market timing”.  In the third and last article in this series on becoming a successful long-term investor, I am going to examine “market timing” with the same stock market data from the S&P 500 Index.  You will clearly see why trying to time the market and buy/sell or sell/buy at the right time is extremely difficult to do (despite what the financial pundits might have you believe given the daily commentary).

How Risky Are Stocks? Do You Understand Volatility? Part 1 of 2

08 Sunday Sep 2013

Posted by wmosconi in bonds, business, Education, finance, Individual Investing, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, math, statistics, stock prices, stocks, volatility, Warren Buffett

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Investors are told over and over that stocks are risky investments.  How true is that though?  If you watch the financial news each day, it seems like there is no reason why stocks go up, down, or remain unchanged at times.  For every financial pundit that gets the direction of the market correct, there are many others that predicted things incorrectly or have been saying that the “sky will fall” for the past five years.  I will admit that stocks are very risky on a daily basis.  However, if you are not running a hedge fund or are a trader on a Wall Street firm’s proprietary desk, the “vicissitudes and vagaries” of the daily moves in the stock market are of no concern to you.  In fact, being too concerned about daily/weekly/monthly/quarterly movements in stock prices will actually hurt your long-term performance.  Investing is not a sprint.  It is a marathon!  If it seems as though the professionals on Wall Street do better than you, please keep in mind that the financial media rarely interviews people that were totally wrong on the market.

I do not like to pick on anyone; however, I will provide one example just to make a point.  Mark Faber, a long-time fixture on Wall Street, predicted that the S&P 500 index would drop to the 1266 level back in November 2012.  Refer to http://moneymorning.com/2012/11/08/stock-market-today-why-marc-faber-predicts-a-20-slide/.   He was recently on CNBC in August 2013 and predicted that the S&P 500 index would by 20% this year.  So is he actually more bullish on his bearish prediction about one year later?  Who knows how to characterize that one?  It is important to learn about stock price movements which are termed volatility in the jargon of Wall Street.  Your Financial Advisor will refer to it over and over when he/she advises you on how to construct your portfolio.

Why does volatility matter to you?  Well, in the very short run, stocks are one of the riskiest investments.  I recently read that over the last 50 years stocks were up 53% of the time and down 47% of the time.  So your odds of being right about one day is essentially a bit better than calling a coin flip.  Now hopefully you are not a speculator.  If you are trying to double your money this year or in even a shorter period of time, you need not read any further.  However, if you would like to learn how volatility affects portfolio construction and portfolio performance over the long term, please read on.

I pulled down some annual returns from the S&P 500 for the period 1926-2012.  Note that the S&P 500 was preceded by a number of other indexes of smaller components, so it is unwise to use this data in full.  Whenever anyone uses statistics to make an argument (myself included), you always need to be very skeptical.  So do NOT make me an exception.  If you look at the S&P 500 index’s performance over the 50 year period from 1961-2010, the annualized performance is a bit less than 9.7%.  Wow, that sounds really good!  However, it seems counterintuitive because the S&P 500 was down over 36% in 2008.  Plus, you may have heard that the 2001-2010 period is often referred to as the “Lost Decade”.  Stocks earned basically nothing over that timeframe.  You need to remember that the 9.7% figure is composed of five decades with different characteristics.  For a primer on how compounding of returns works, you can refer to one of my earlier posts:  https://latticeworkwealth.com/2013/07/08/double-edged-sword-of-the-power-of-compounding/.  The aforementioned annualized return of the S&P 500 index over the last 50 years is composed of the following returns for each decade:  8.1% (1961-1970), 8.5% (1971-1980), 13.8% (1981-1990), 17.3% (1991-2000), and 1.4% (2001-2010).  You will most certainly remember the financial crisis of 2008 and the Internet Bubble of 2001.  These major events in the stock market took a huge toll on performance returns over the last decade in this series.  With that being said, Time magazine had a cover story in 1982 where they declared the de facto death of equities.  Oddly enough, it turned out to be the beginning of the strongest bull market in history.  Why is it important to decompose this data?

The importance lies in human nature.  An annualized return of 9.7% means that an investment in stocks should essentially double every five years.  Well, if your Financial Advisor invokes market history when building your portfolio, he/she may set your expectation that you can expect to double your money in stocks every 5 years.  What if it takes longer or you do not double your money after even a ten-year period like 2001-2010?  Humans tend to seek patterns and be risk averse.  Many of the great bubbles over time have come because financial professionals extrapolate from the past, be it with stock prices, corporate earnings, or housing prices more recently.  We look at the immediate past for a guide to the future.  This analysis is called ex post facto, and, as you can see above, it can get you into a lot of trouble.

Many investors used the 1980s and 1990s as a guide to what would happen in the 21st century.  In fact, there were books written and predictions of why the Dow Jones Industrial Average (Dow Jones) would reach 36,000 which is more than twice its current level as of September 2013.  I have met many investors that are still shying away from buying stocks because of the Internet Bubble of 2001 and the financial crisis of 2008.  Now I am not making a prediction about the future direction of the stock market, my only observation is that people tend to wait too long to get back into the market if they attempt to time the market properly.  Everyone wants to buy low and sell high.  Furthermore, they want to sell all their holding right when the market reaches its highs.  Buying stocks and holding them for the long term is not really all that much fun.  When I was 13 years old and buying stocks in the late 1980s, I know I wanted to double my money each year.  I got frustrated really quickly; however, I kept plugging away and investing more every month.

After the experience many had in the stock market from 1966-1982, they felt it was unwise to invest in stocks at all.  The Dow Jones was essentially unchanged during that period.  Very few Financial Advisors were recommending the purchase of stocks in the early 1980s.  Conversely, most every Financial Advisor was recommending the purchase of stocks throughout the late 1990s.  As humans, we tend to seek out patterns in history and, even subconsciously, think that the past will repeat itself.  You may think that you do not fall into that category, but I urge you to think about your experience with the stock market in 2001, 2002, and 2008.  Did you sell all your stocks, hold them, or buy more stocks during those years?  I can remember 2003 where it was very unfashionable to still invest in stocks.  It is easy to say that you will not succumb to the pressure to sell stocks, but, after the stock market fell over 35% in 2008, many investors just had enough.  Imagine you had $1,000,000 on January 1, 2008 and opened your brokerage statement on December 31, 2008 only to see the balance was $640,000.  Hard dollar figures are much more impactful than testing your risk tolerance by wondering if you would sell your stocks if the market went down 10%, 20%, or 30%.

Your Financial Advisor will talk to you about diversification and the benefit of holding securities in many different asset classes.  Moreover, you will be told over and over again that stock price volatility is bad and hurts your returns.  I will agree that stocks are volatile, but the assertion that Modern Portfolio Theory (MPT) makes about risk/return can lead to odd answers.  Here is a homework assignment.  Ask your Financial Advisor if he/she remembers how stocks performed during 1987.  Of course, everyone remember the huge crash in October, but very few remember that the stock market was actually up a bit over 2% that year (S&P 500 index).  Why does that even matter?

Well, stock price volatility is measured by statistics.  Think of the bell curve in your days in school.  The bell curve has been used in education which basically states that most of the students will be average and get a grade of C.  There will be other students that get B’s and D’s as well.  Of course, there will be a small group of students that fail a class or exam or do extremely well and get an A.  MPT tells investors that volatility is bad.  It is bad in terms of the decisions you might make, but there are many odd answers given by the theory.  For example, the average daily return of stocks in was roughly 0.03%.  The main measure of volatility is standard deviation, and you do not need to worry how to calculate it.  Standard deviation simply measures how far from the average a series of numbers in a population is like daily stock returns.  The standard deviation for daily returns was about 2.0%.  The annualized standard deviation was 31.8% (just so you know standard deviation is not additive in nature, so it takes some mathematical manipulation to get to that answer).  Why did I present these numbers?  I presented them to make another observation.  In 1973 and 1974, the S&P 500 index was down 14% and 26%, respectively.  However, the annualized standard deviation for each of those years was 15.6% in 1973 and 21.6% in 1974.  Thus, those years were less volatile than 1987, but an investor would have lost a large amount of money in each year.  Would you rather make money during the course of a year or lose money over the course of the year with less volatility?  If you are a long-term investor, daily fluctuations in the stock market should not guide your decisions.  Otherwise, you will end up selling all your stocks just because prices are going up and down a lot.  The most important thing is the terminal value.  The terminal value just means what the return will be at the end of the period without regard to the volatility over the course of the year.

The validity or, more aptly usefulness, of MPT becomes more apparent when we look at daily returns.  MPT makes a lot of assumptions, one of which is that stock prices will follow the normal distribution.  That is just a fancy way of saying the bell curve.  Now if you know about statistics, you can make predictions about a set of data based upon the historical experience of that data.  I downloaded the daily returns of the S&P 500 from 1957-2012 because I had some extra time on my hands and was bored.  The average daily return of the index was 0.03% with a standard deviation of 0.98%.  If you assume the normal distribution holds, you can make the assertion that 99% of all observations should be within a low daily return of -2.25% and a high daily return of 2.31% (Formula is average – standard deviation * 2.33 and average + standard deviation * 2.33).  You might ask if that is really true.  This way to express the data means that the daily return for the stock market should be equal to or between those two figures 99 out of every 100 trading days.  In statistical terms, it is referred to as a 99% confidence interval.  What about the market crash in 1987?  The S&P 500 index dropped 20.5% on October 19, 1987.  How would you express that statistically?  In order to have a daily return that far away from the average, it equates to approximately 21 standard deviations from the average.  How likely is that?  It is pretty much the same odds of flipping a coin 20 times and having it come up heads each time.  Keep in mind that this date was not the only big drop over this period.  For example, there were over 20 times when the S&P 500 index dropped by 5% or more in a day during that period.  The likelihood of that happening over the course of 55 years (1957-2012) is infinitesimal.  If you would like to learn more about this type of odd result, I would encourage you to read the book, The (Mis)Behavior of Markets, http://www.amazon.com/The-Misbehavior-of-Markets/dp/B008A0LNBM/ref=sr_1_2?ie=UTF8&qid=1378664066&sr=8-2&keywords=The+Misbehavior+of+markets.

Suffice it to say that the path of stock prices does not follow the normal distribution.  Now academics will admit that is the case and have made modifications to MPT.  Additionally, most academics will use the lognormal distribution or other distributions to explain the volatility of stock prices.  However, the mathematics becomes exponentially more difficult and challenging.  With that being said, the financial advice given to you from your Financial Advisor is likely to be taken from the first iteration of MPT.  If you have heard your financial professional talk about beta, alpha, sigma, mean, r-squared, and the like, he/she is constructing your portfolio by making reference to the ideas laid out by MPT.  Now I will not go so far as to say MPT is incorrect.  Much smarter folks than me developed it.; believe me!  However, the great Warren Buffett gave a speech back in 1984 that encapsulated why MPT he does not subscribe its tenants.  To see a transcription of the speech, refer to:  http://www.bestinver.es/pdf/articulos_value/The%20Superinvestors%20of%20Graham%20and%20Doddsville%20by%20Warren%20Buffett.pdf.

In the next part of this discussion, I will attempt to show you how to look at the volatility of stock prices in the context of your portfolio.  If you do not need to withdraw money from your portfolio on a short-term basis, MPT has less and less applicability for you.  MPT assumes that all investors have a one-year time horizon.  Therefore, if you do not plan on needed to withdraw money over the course of a 12-month period, this discussion definitely will apply to you.  You should be looking at your portfolio in terms of one-year and five-year increments.

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