Methodology

Modern Portfolio Theory

Criticism of Modern Portfolio Theory

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. 

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. 

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. 

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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