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Traders think that money grows from speculation, but indexers know it’s just risk compensation.

I

– The Speculation Blues

1950s, a young Harry Markowitz applied his mathematical expertise to investing. Markowitz, then a Ph.D. candidate in economics at the University of Chicago, believed investment professionals erred by urging investors to focus solely on returns of individual stocks with no consideration of the concept of risk exposure. He set out to reveal how investors could improve their stock market investing performance by optimizing the trade-off between risk and return. In his 1952 Nobel Prize-winning paper, “Portfolio Selection,”89 Markowitz established the importance of diversification. He asserted the best portfolios include non-correlated stocks that act and move independently from each other. Today, I estimate that trillions of dollars worldwide are invested according to his principles of risk and return, known collectively as Modern Portfolio Theory. The blend of investments that is appropriate for a particular investor is known as asset allocation, also called risk exposure, and is based on an investor’s risk capacity. Asset allocation is the most important factor in optimizing a portfolio’s expected return, thus it is essentially the most important decision an individual investor can make. This concept also extends to larger institutional investments, such as state pension funds, fire and police pension plans, non-profit and for-profit defined n the early

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This book reveals the potential land mines and pitfalls of active investing and educates readers on the benefits of passive investing with i...

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