Random Walks and Portfolio Allocation

Fundamentals of Market Investing by Adam J. McKee

Professor Malkiel has much to say on modern portfolio theory, which is basically the idea that people should hold a diverse range of investments and that these investments should maximize the rewards while minimizing the risk.  Malkiel essentially argues that it does not matter how much you diversify your stocks (and other assets), you are still wide-open to some risk.

In general, he has some admiration for modern portfolio theory, but he goes on to point out why minimizing risk isn’t always the best strategy.  He also considers the use of tilts, such as beta, in this context.  Recall that beta is a number that expresses how closely an individual stock matches the behavior of the whole stock market in the past.  Thus, in theory, stocks with a high beta should jump like crazy during a bull market and then dive during a downturn.  In practice, Malkiel concludes, beta-based portfolios rarely achieve alpha.

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Last Updated: 6/25/2018

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