It's rather poignant that Harry Markowitz--the father of modern "index" investing--passed away in late June, in the midst of a stock-market year that pretty much no one saw coming.
It was supposed to be a year of "modest" returns, recession's arrival, and "The End of FANG." Instead, the Nasdaq has soared 32% year-to-date, the S&P 500 is up 16%, and the Dow would be joining them if it had replaced Intel with Nvidia, but instead is only up 4%. Strategists have been scrambling to keep up. Stock pickers and active managers are in some cases doing fine, in other cases doing quite poorly, and in some sectors facing existential crises.
All of which feeds Harry's point, that you shouldn't try to pick stocks or time the market (especially as an individual investor). Instead, you should just be as broadly diversified as possible, at low cost, and with minimal turnover of your holdings.
There's a fun story, actually, about how Markowitz, a mathematician, wound up applying his work on statistical distribution to the stock market. As his friend and colleague Mark Hebner told us the other day, it was all because a stock broker happened to be in the adviser's office when Harry went in to discuss his dissertation ideas one day, and suggested he apply those insights to the stock market. (Hebner has a library of Markowitz interviews here.)
This was back in the early 1950s, and Harry's ultimate research piece on "Portfolio Selection" became a core building block of the "diversification" principle that ultimately gave rise to the huge move over the past several decades towards index investing.
When I spoke with Mark earlier this week, I asked him if he saw the investing world today as the triumph of Harry's ideas in practice. He said no--or not yet, anyway. Too many individual investors are actively trading index ETFs, he said, as opposed to just picking a handful of diversified indexes--US, international, large-cap, small-cap, etc.--to lock away.
I told him I was skeptical of the need to hold, for instance, international stocks at all, which typically underperform and have extra currency risk, but Mark insisted this is a key part of the Harry strategy. "The bigger the universe of stocks you hold, the more you narrow the distribution of possible returns in a given year" to something closer to the 10% average that stocks roughly return over time, he said.
In other words, the broader array of stocks you hold--including international stocks, which outperformed into and during the global financial crisis--the more likely you are to earn the market's long-term average in a given year, as opposed to finding yourself in one sharply underperforming asset class. But most people don't want to give up the potential 60% upside in a single stock or ETF they think they can identify ahead of time. Unfortunately, they often end up underperforming as a result.
And does Mark, whose own firm is called "Index Fund Advisers," worry that index investing itself has become a bubble now? No, he said, but he did emphasize that just owning the S&P 500 is not the full diversification that he or Harry envision ("it means big-cap, small-cap, value, growth, foreign and domestic," as Harry once said.)
For what it's worth, Harry was also a big fan of rebalancing, and his diversification included into bonds as investors get closer to retirement age. So yes, a lot of this has been incorporated into the modern investing world. But as the last couple years of "meme stock" mania have shown, we still seem to have a long way to go.
Have a great weekend!
Kelly
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