How modern portfolio theory can be used to manage the portfolio of Essay

How modern portfolio theory can be used to manage the portfolio of your own_ - Essay Example The pros barely edged the DJIA by a margin of 51 to 49 contests† (Investor Home, 2011). An investor simply parking their money in the Dow would have beaten the specific picks of the professionals about half the time, even without transaction costs or taxes. Even worse, later research found that the pros got a break due to the announcement effect of the stock (Liang, 1996). When the pros made an announcement, others invested naively, but these stocks later reversed quite quickly: When taking this into account, the pros did not beat the dartboard! And in the last year of the contest, the readers won slightly (Jasen, 2002). All of this seems to sink the idea of portfolio analysis: If the best pros in the world using the best techniques can't beat random chance, how can anyone? But modern portfolio tools have given investors, particularly newer ones, skills for constructing an asset portfolio that will beat out mutual funds and naive investment. The Failure of Mutual Funds It's not just professionals that struggle to create value. Mutual funds are also very bad at generating growth, and they have the advantage not only of many investors and many analysts but also time and a diverse portfolio! â€Å"By and large, what you're going to find is that very, very few active funds consistently match the performance of the various indexes over the long-term, much less beat them... Finding a fund that consistently beat its index is like looking for a needle in a haystack† (Distad, 2009). Distad's data shows that very few funds beat out the market over time. Further, he notes that many of these actively managed funds are highly unreliable in terms of their fidelity. 80% had performance history only going back a year, out of a random sample of almost 3500 funds! Investors need to construct their own portfolio, not just rely on mutual funds that have had a mixed record of success and have certainly suffered after events like Enron, WorldCom and the 2008 collapse. A ssets Chosen I chose two assets: Whole Foods (WFMI) and Nintendo (NTDOY.PK). I wanted to pick two assets, one of which was more of a growth asset and another which was an asset that produced products I was familiar with and that I knew something about the likely market response to. The goal for both was risk control first and growth second: That is, I wanted there to be a steadiness to the line, whether it was going horizontally or sloping upwards. I selected based off of a visual analysis of both companies over five years, then used iQfront's analysis to see what the statistics were, and was pleasantly surprised. Modern portfolio theory emphasizes that risk has to be measured based on the variance of the stock (Goetzmann, 2011). Indeed, the core idea is that a tangency line can be created that has a riskless asset used as a baseline for comparison where both risk-averse and risk-accepting investors could invest comfortably, a perfect middle ground (Goetzmann, 2011). But finding tha t perfect portfolio is difficult, because â€Å"a major difficulty in estimating an efficient frontier accurately is that errors grow as the number of assets increase. You cannot just dump all the means, std's and correlations for the world's assets into an optimizer and turn the crank† (Goetzmann, 2011). We will return to why analyzing risk this way is compelling since other forms of risk are so appallingly inaccurately determined (Danielsson, 2009). In any respect, while growth is easy to measure (just look at how it's