Finance: What is Modern Portfolio Theory?

Modern Portfolio Theory claims there's a smart way to invest. If it's not "put all your money under your mattress," we might be doing it wrong...

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Transcript

00:24

and really didn't worry about much else And well math

00:27

hadn't really been invented yet So like who knew that

00:30

If all right well then along came harry markowitz in

00:33

nineteen fifty two who tried to science and math the

00:37

crap out of the stock market What he came up

00:39

with was modern portfolio theory which basically said that there

00:44

was a smarter way to invest than just you know

00:47

putting your life savings into blockbuster because you like the

00:51

logo using all sorts of advanced metrics that we won't

00:54

torture you with here The theory he devised was that

00:58

well rather than throwing your money against the wall to

01:01

see what sticks you could use extensive elaborate data to

01:04

determine the best way to maximize your returns depending on

01:08

how much risk you were willing Teo you know risk

01:11

And there are five key ideas behind modern portfolio theory

01:15

And yes of course we have videos on each of

01:17

these The first is alfa which is kind of like

01:20

how smart you are in the market Then there's beta

01:22

which is about volatility in a broadway The vics we

01:26

got a whole video set on that Then they're standard

01:29

deviation and no that's not some kinky reference to fifty

01:32

shades It's more about how the market diverges from your

01:35

given individual stock pick and volatile things are finally the

01:39

beta then there's our squared it's all about how a

01:42

stock or a given index conforms to a given line

01:46

or expected return ratio Like how close it is how

01:49

proximate is And then finally you have the sharpe ratio

01:53

Thank you bill sharp from stanford university who also talked

01:56

about being smart in the market so that you could

01:59

evaluate your rich turns whether they were smart or just

02:02

a lottery ticket Lucky Oh and we're probably not such

02:05

a wise investment in the beginning even though they turned

02:08

out okay That would be sort of the sharpe ratio

02:10

Yeah all right Well in general mpt skews toward less

02:13

risky investments but it all comes down to risk reward

02:17

Tolerance in the end if for whatever reason you feel

02:20

supremely confident that radio shack is about to make a

02:23

massive come back well you might be able to justify

02:26

taking more risk in loading the dice But to be

02:29

clear radio shack was just a bad example So kids 00:02:33.29 --> [endTime] don't try this at home