Harry Markowitz, who received the 1990 Nobel Prize in Economics for his contributions in creating modern portfolio theory, passed away recently. He introduced the use of mathematical methods to illustrate the power of diversification and how you can combine multiple different components into a portfolio that can achieve the highest expected return while taking on the minimum amount of risk. This NY Times obituary outlines his long list of achievements.

These days, anyone can run many backtests to optimize for a historically optimal portfolio using a number of different asset classes (as of today, it will be different in 5 or 10 years). However, if you listen to many of his interviews, Markowitz doesn’t necessarily think the average investor needs optimize relentlessly. Here are some useful quotes that don’t require any advanced math.

From his landmark 1959 book Portfolio Selection: Efficient Diversification of Investments:

A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies.

How did Harry Markowitz actually run his own personal portfolio? From Jonathan Zweig’s NYT article about emotions and investing:

Mr. Markowitz was then working at the RAND Corporation and trying to figure out how to allocate his retirement account. He knew what he should do: “I should have computed the historical co-variances of the asset classes and drawn an efficient frontier.” (That’s efficient-market talk for draining as much risk as possible out of his portfolio.)

But, he said, “I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.” As Mr. Zweig notes dryly, Mr. Markowitz had proved “incapable of applying” his breakthrough theory to his own money. Economists in his day believed powerfully in the concept of “economic man”— the theory that people always acted in their own best self-interest. Yet Mr. Markowitz, famous economist though he was, was clearly not an example of economic man.

From a Chicago Tribune interview by Gail MarksJarvis:

Early in his career, he did not take the risks some investment advisers suggest for young investors to maximize returns. Rather, he saved regularly and put half his money into stocks and half into bonds to grow while controlling risks. When he thought he had accumulated too much in either category, he stopped putting money there for a while and directed savings to the neglected group. […]

“I never sold anything,” he said. If stocks were increasing in value, he would let that portion grow for a while, but eventually he would stop stock purchases and beef up the bonds. The idea: The bonds would insulate him from the downturns that crush stocks from time to time without clear warning. […]

“Say you were 65, and invested $1 million, with 60 percent in stocks and 40 percent in bonds,” he said. “It became $800,000 [during the financial crisis], and you are not happy, but you lived to invest another day.”

From this Business Insider article via Bogleheads forum post (emphasis mine):

In an interview with Personal Capital, Markowitz was asked, “What are the top pieces of advice you give people about money?”

“I only have one piece of advice: Diversify,” he replied. “And if I had to offer a second piece of advice, it would be: Remember that the future will not necessarily be like the past. Therefore we should diversify.“

From ThinkAdvisor:

“Perhaps the most important job of a financial advisor is to get their clients in the right place on the efficient frontier in their portfolios,” he told me. “But their No. 2 job, a very close second, is to create portfolios that their clients are comfortable with. Advisors can create the best portfolios in the world, but they won’t really matter if the clients don’t stay in them. “

Thank you, Mr. Markowitz, for your contributions to economics, behavioral finance, and investing. Thanks also for the simple, actionable lessons that don’t require a degree in mathematics or economics: keep saving regularly, maintain a diversified portfolio of both stocks and bonds, rebalance when it gets off, and stick with it for a long time (don’t panic sell).

Image credit: Quantpedia

These days, when I see an article titled The Best Current Sources of Retirement Income, I expect to be pitched some sort of options-based ETF with 12% yield or high-yield junk bonds with a 9% yield. However, this Morningstar article actually provided a reasonable comparison of three high-quality options for “guaranteed” income:

• Traditional US Treasury Bonds, which offer a fixed interest payment for the remaining term of the bond (plus return of principal).
• Treasury Inflation Protected Securities (TIPS), which offer a variable interest payment that is a fixed amount above an inflation-linked index (plus return of principal).
• Single Premium Income Annuities, where you put up all your money upfront and then receive a fixed amount for the rest of your lifetime.

There are some additional assumptions, but here is a chart assuming a $100,000 investment, starting at age 65 with a 20-year time horizon that experiences 2.4% annual inflation (2.4% is the average long-term prediction of future inflation):

The chart seems to suggest that if you buy an annuity and then die the next year, you would lose your entire $100,000. That can be the case, but every SPIA annuity quote that I’ve seen offers the option to guarantee a certain minimum number of payments like 5 or 10 years of income, or a complete return of premium ($100,000 in this case). You do pay for this additional rider in the form of a lower monthly payout, but it is a popular option.

Don’t forget about Social Security. The article reminds us that an alternative option for government-guaranteed, inflation-adjusted income is to delay your Social Security start date and increase your future monthly payments for the rest of your life. Your cost is using your own funds to replace your income during those additional delayed years before claiming.

The results are about as you might expect, but it’s nice to see it illustrated using charts. My lightning recap:

• Moderate inflation (2.4%) + Average Lifespan: Mostly a tie.
• High inflation (5%) + Average Lifespan: TIPS win.
• Low inflation (1%) + Average Lifespan: Treasury bonds win.
• Moderate inflation + Extended Lifespan: SPIA lifetime annuity wins.

Since we don’t know the future, there is no “best” option. However, this comparison helps you understand why you’d own each option. If everything goes as forecasted, it won’t really matter what you pick. But I bother with owning all three types because I like knowing that I am covered in all of the more extreme scenarios. I don’t plan on buying a lot of private annuities, however, as Social Security is already an annuity that offers lifetime inflation-adjusted income. If needed, I plan to simply delay my Social Security claim date if I wish to increase my annuity allocation.

Morningstar has been running an interesting series of articles on “Do Nothing” portfolios where they take the idea of “Buy and Hold” to the extreme. When you buy and hold a traditional index fund, the holdings still change over time. New companies are added, companies are merged or acquired, and some are taken out every year.

What if you instead bought the individual stocks in the S&P 500 from 10 years ago, and then did absolutely nothing? You wouldn’t buy any new companies. If a company was bought out, you just kept the cash. (Dividends were reinvested.) From the article What Beat the S&P 500 Over the Past Three Decades? Doing Nothing, you would have found out that the “No Nothing” portfolio has actually outperformed the S&P 500 during this 2013-2023 period by a tiny bit:

John Rekenthaler extended this backtest to the past 30 years. The “Do Nothing” portfolio still won slightly from 1993-2023. From the article More Lessons From the Do Nothing Portfolio:

He added a real-world example of “buy and hold forever” in the Voya Corporate Leaders Trust (LEXCX), which is a very quirky mutual fund that essentially bought equal amounts of stock from 30 of the largest US companies back in 1935 and then sat on its hands. Voya Corporate Leaders Trust also did quite well over the same 1993-2023 period:

So we should all just do nothing right? Well, not so fast. The next article The Ultimate Buy and Hold Portfolio examined buying the 10 largest US companies as of December 1986 and then doing nothing. That result wasn’t as great, and it didn’t help if you held them by market-weight, equal-weight, or rebalanced. The Total US Stock Market index (Wilshire 5000) won by a large margin, although the gap only really widened after 2010.

It appears that doing nothing can do surprising well, but you still run the risk of missing out on owning some breakthrough companies over the long run.

My takeaway is that we should be very thankful that we can buy a simple, low-cost Total US stock market or S&P 500 index fund and just “do nothing” while it does all the work. The market cap-weighting system automatically adjusts to include new companies in whatever new industry may emerge. You don’t have to worry about missing out on the next Apple or Google. I sleep well knowing that I will always own the entire haystack and all the needles inside.

If you own a target retirement fund, you probably own a decent chunk of international stocks. However, these days it’s harder to find people telling you to own international stocks when you build your own portfolio, mostly because of the outperformance of US stocks over non-US stocks for long time now. The article International Diversification – Still Not Crazy after All These Years does a good job of reminding us why owning some international stocks is still a good idea. Here’s the brief summary:

International diversification has hurt US-based investors for over 30 years, but the long-run case for it remains relevant. Both financial theory and common sense favor international diversification, which is buttressed by empirical evidence that is very supportive at longer horizons and for active strategies. Finally, it would be dangerous to extrapolate the post-1990 outperformance of US equities, as it mainly reflects rising relative valuations. If anything, the current richness of US equities may point to prospective underperformance.

For one, the diversification benefits in times of market crashes are still there… as long as you expand your time horizon. The major risk for a US-only portfolio is a prolonged recession in the US, while the rest of the world recovers more quickly. The “insurance” analogy still applies as historically there has definitely been a cushioning effect over time from spreading your bets.

Exhibit 1 shows that over short horizons, global portfolios (dashed) can suffer almost as much as an average local portfolio (dot- ted); but once you look out a couple years or so, global portfolios fare much better.

Exhibit 2 tracks the Shiller CAPE ratio (Cyclically-Adjusted Price/Earnings ratio) of US stocks and EAFE developed international stocks. The red line represents ratio between the US and EAFE valuations. Much of the historical outperformance of the US over EAFA stocks since 1990 was not earnings growth itself, but expansion of the P/E ratio (how much you pay for those earnings).

Will US stocks permanently maintain a P/E ratio that is 50% higher than international stocks? I have no idea, but it’s definitely not a sure thing. I let my portfolio asset allocation float with the market weightings (with a slight US tilt since I live here), so I don’t really worry about it because if US stocks keep growing faster than international stocks, then I’ll just gradually end up owning more US stocks while paying a sort of insurance premium hit for owning the international stocks. But if international stocks end up making even a minor improvement like a return to valuation ratios pre-2010, my portfolio can still benefit.

The 2023 Berkshire Hathaway Annual Shareholder Meeting occurred on May, 6 2023, and while there are articles offering highlights (including this one), it’s never the same feeling as watching/listening to the actual thing. I always find a few things that mean something to me, even if just a small side remark, that don’t make it into the financial news headlines. Warren Buffet (92) and Charlie Munger (99) continue to impress with their amazing mental acuity and stamina.

CNBC again has the rights to record and host the full video and transcripts (morning session, afternoon session) and they did a nice job with syncing the text and sound on the afternoon session (the morning one didn’t work for me). Here are a few personal takeaways and notes.

Overall, I am reminded that Buffett regards Berkshire Hathaway as his life’s work and masterpiece. He may not have much time left to paint, but it is already beautifully constructed. It is built to prosper in the long-term, but also to withstand anything thrown at it in the short-term. This is how I wish to build up my family’s finances as well. A large engine of productive investments that create growing profits and cashflow. Always having a sizable cash holding as well, never having worry about market crashes or liquidity needs. Berkshire sells insurance to cover the rare events, and I buy them to protect us from those types of events (life, home, auto liability, umbrella).

Autopilot. Buffett points out that it will be hard to judge how well his successors are doing, as by design, Berkshire will operate very well even mostly on auto-pilot. The subsidiary companies all have their own managers. The stocks are bought with the intention of holding for a long time if not forever. This reminds me that I should make our finances more auto-pilot as well. I may enjoy the micro-management now, but I worry that I am making things too complicated in a situation where I’m not around.

The benefits of being financially independent. No boss above telling you what to do, but also no direct customers to please.

[Warren Buffett speaking about Charlier Munger] He didn’t want to sell his time, maybe at 20 bucks an hour or something, to people he thought were making the wrong the decisions. And he knew more about it than they did. And that just did not strike him as a good way to go through life. And I think he’s probably right on that.

I think he’d have really gotten to be miserable if he had to keep doing that. It’s just no fun. It’d be like me giving investment advice to somebody that — or taking it from somebody. I just wouldn’t want to do it. And Charlie figured that out. And so, we decided to work for ourselves. And this worked. Been happy, happily ever after.

Charlie Munger was a successful lawyer, but he didn’t want to give advice to people who often wouldn’t take it. Warren Buffett could have been a investment manager or financial advisor, but he also didn’t want to give advice to people who often wouldn’t take it. I have thought about becoming a financial advisor of some sort, but I think it would be very difficult to spend your time carefully crafting advice and then seeing someone just do the opposite. As a self-directed investor, I enjoy the fact that I can do my own research, make my own decisions, and implement them as I wish. It takes a while to build up your first $100,000, but there is a reason why his biography is called The Snowball.

Berkshire shareholders as the frugal millionaires. I have to admit, I enjoy the stereotype that Berkshire Hathaway shareholders tend to be frugal, practical, and not focused on outward appearances. Here’s a funny anecdote that speaks to that (even though Munger now flies NetJets, a Berkshire subsidiary).

CHARLIE MUNGER: I used to come to the Berkshire annual meetings on coach from Los Angeles. And it was full of rich stockholders. And they would clap when I came into the coach section. I really liked that. (LAUGHTER) (APPLAUSE)

How to live a good and successful life. Buffett has said this quote before, but it’s a good one:

…you should write your obituary and then try and figure out how to live up to it.

Charlie Munger expands:

CHARLIE MUNGER: Well, it’s so simple to spend less than you earn, and invest shrewdly, and avoid toxic people and toxic activities, and try and keep learning all your life, et cetera, et cetera, and do a lot of deferred gratification because you prefer life that way. And if you do all those things, you are almost certain to succeed. And if you don’t, you’re going to need a lot of luck. And you don’t want to need a lot of luck. You want to go into a game where you’re very likely to win without having any unusual luck.

… the toxic people who are trying to fool you or lie to you or aren’t reliable in meeting their commitments. A great lesson of life is get them the hell out of your life. […] And do it fast. […] I don’t mind a little tact. Or even a little financial cost. But the question is getting them the hell out of your life.

Again, my favorite way is to listen to the audio track of the CNBC or YouTube videos in the car like a podcast over multiple days. If you’d rather read more detailed notes, check out the CNBC Liveblog, Kingswell and Rational Walk.