Modern Portfolio Theory

Criticism of Modern Portfolio Theory

1

A major flaw of MPT is that it uses stock chart information from the past and doesn’t necessarily reflect how a stock/portfolio will perform in the future. A portfolio may not perform the same in the future.

2

Another issue is that MPT is based on variance and not downside risk. This is a problem because two portfolios that have the same variance and expected return will be considered equal under MPT.

3

However, one portfolio may have that variance due to frequent small losses, while the other portfolio may have that variance due to rare but significantly large declines.

4

Most investors would prefer to make small losses frequently, rather than experience significant declines. This may be a challenge for the psychology of the investor, influencing their decision-making process.

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