using portfolio theory effectively
DESCRIPTION
A Study of Mistakes, Theories & ApplicationTRANSCRIPT
Using Portfolio Theory Effectively
A STUDY OF MISTAKES, THEORIES & APPLICATION
PLAMEN TODOROW
KELLEY SCHOOL OF BUSINESS
Market EfficiencyInvesting Mistakes
Theories
Applications
Market EfficiencyInvesting Mistakes
Theories
Applications
Market Efficiency
Firm Foundation
Theory
Market Psychology
Trading Techniques
Crashes / Valuation
Market EfficiencyInvesting Mistakes
Theories
Applications
Market Efficiency
Firm Foundation
Theory
Market Psychology
Trading Techniques
Crashes / Valuation
Intrinsic Value• In equity, intrinsic value is usually utilized by
fundamental analysis
• Intrinsic value is the actual value of a company based on tangible and intangible assets
• Intrinsic value measured:• Earnings assumptions• Growth assumptions• Confidence margin
Market EfficiencyInvesting Mistakes
Theories
Applications
Market EfficiencyInvesting Mistakes
Theories
Applications
Market Efficiency
Firm Foundation
Theory
Market Psychology
Trading Techniques
Crashes / Valuation
Market EfficiencyInvesting Mistakes
Theories
Applications
Market Efficiency
Firm Foundation
Theory
Market Psychology
Trading Techniques
Crashes / Valuation
Types of Stocks
• Growth vs. Value– Which strategy is better?
Market EfficiencyInvesting Mistakes
Theories
Applications
• Future: Grow faster than market
• Dividends: Few or noneGrowth Stocks
• Discount/Undervaluation
• Dividends: No limitValue Stocks
Stock Analysis• Techniques:
– Fundamental Analysis– Technical Analysis– Momentum Investing
Market EfficiencyInvesting Mistakes
Theories
Applications
Why Equity Trading Strategies Don’t Work
• They become outdated with new trends
• If a successful strategy exists, influx of new investors will mitigate and eventually wipe out additional gains
• Case in point: January effect Santa Claus effect
• Excessive brokerage costs, risk, and tax implications
Market EfficiencyInvesting Mistakes
Theories
Applications
Market EfficiencyInvesting Mistakes
Theories
Applications
Market Efficiency
Firm Foundation
Theory
Market Psychology
Trading Techniques
Crashes / Valuation
Common Portfolio Mistakes
Starting a portfolio
with stocks
Timing the
Market
Excessive Trading
Portfolio Imbalance
Not Dollar-Cost
Averaging
Unnecessary Risk Levels
Portfolio Imbalance
Market EfficiencyInvesting Mistakes
Theories
Applications
Capital-Asset Pricing Model (CAPM)
Market EfficiencyInvesting Mistakes
Theories
Applications
Risk and Return• To understand portfolio theory, realize the
relationship between risk and return
• CAPM asserts that to get a higher average long-run rate of return beta in portfolio should be higher
Market EfficiencyInvesting Mistakes
Theories
Applications
Stock Market Simulators
• www.Investopedia.com
• www.UpDown.com
• www.caps.fool.com
Market EfficiencyInvesting Mistakes
Theories
Applications
ETF AdvantagesYou know what you own
Diversification + tax advantages
ETF’s tend to have low turnover
Not exposed to fallacies of individual stock investing
Market EfficiencyInvesting Mistakes
Theories
Applications
Efficient Asset Mixes for Different Levels of Risk
Portfolio Risk Level
0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.5
Cash 100% 35% 25% 4% 0% 0% 0% 0%
Bonds 0% 55% 42% 50%
35% 19% 0% 0%
Large-Cap Stocks
0% 6% 17% 29%
33% 38% 43% 33%
International Stocks
0% 4% 14% 17%
20% 22% 29% 20%
Small- and Mid-Cap Stocks
0% 0% 2% 0% 12% 21% 28% 47%
Utilizing An Optimal Portfolio
18
Proper portfolio allocation requires investing in mix of low and high beta investment vehicles
High Beta
Low Beta INCREASED WEALTH
POTENTIAL
Low Beta Vehicles
High Beta Vehicles
Optimal Mix
Market EfficiencyInvesting Mistakes
Theories
Applications
Period Investment Price of Fund Shares
Shares Purchased
1 $150 $75 2
2 $150 $25 6
3 $150 $50 3
Total Cost $450
Average price $50
Total shares owned
11
Average cost: $41
Percentage of Total Expected Return Lost to Fees
Percentage of Total Expected Return Lost
Fund Type +0.10% Incremental
Fee
+0.25% Incremental
Fee
+0.50% Incremental
Fee
Money Market/ Cash
6.0% 15.0% 30.0%
Bonds 3.3% 8.3% 16.7%
Large-Cap Stocks
1.4% 3.6% 7.2%
Small/Mid-Cap Stocks
1.3% 3.2% 6.4%
International Stocks
1.5% 3.6% 7.3%
Be An Intelligent Investor
• Isaac Newton, a fool?
• Patience, discipline, andeagerness to learn aremost important tools
• People who invest makemoney for themselves;people who speculatemake money for theirbrokers
Questions?
“The business schools reward difficult complex behavior more than simple
behavior, but simple behavior is more effective.” –Warren Buffet
S&P 500 Price Dividend Ratio
http://static.seekingalpha.com/uploads/2008/10/13/saupload_sp500_20price_20dividend_20ratio_20long_20term_20chart.png