>> Eric Schurenberg: The disaster in the stock market has toppled a few of what have long thought to be the pillars of good investment practice. One of those pillars has to do with portfolio strategy. Joining me today is the man regarded as the "Father of Modern Portfolio Theory," Harry Markowitz, Nobel Lariat and Professor at the Rady School of Management at the University of California in San Diego. Harry thanks for being here.
>> Harry Markowitz: Thank you.
>> Eric Schurenberg: Now in this broad market collapse, a lot of things didn't seem to work as advertised. Did you think that portfolio strategy and diversification held up as you expected?
>> Harry Markowitz: Well you have to distinguish between high beta stocks and low beta stocks. A beta is the extent to which you would expect a given security to go up and down with the market. So the S and P 500 has a beta of roughly 1. A merging market has higher beta. Bonds have lower beta. And in fact while the S and P went down 38 and a half percent, the emerging markets went down much more. Corporate bonds went down very little. Government bonds went actually up. So those things performed as one would have expected.
>> Eric Schurenberg: A lot of people's experience of portfolio practice is a financial planner plugging their investments into a calculator and making minor adjustments in there waiting of value oriented stocks and growth oriented stocks. Is that form of diversification oversold?
>> Harry Markowitz: Well it's important to know that there is no high return with no risk. Portfolio theory - modern portfolio theory - presents the user with a risk return trade-off curve. If you want a high return on the average, you have to put up with volatility in the short run. If you want stability in the short run, you have to take less return on the average. So one of the jobs of the - important jobs - of the financial advisor, is to make sure that the client gets to the right point on this risk return trade-off.
>> Eric Schurenberg: When it comes to applying modern portfolio theory to their own investments, their own 401Ks say, what mistakes do investors typically make?
>> Harry Markowitz: The typical mistake of the small investor is to buy when the market is high and they think it's going to go higher and then sell when the market is low and they think it's going to go lower.
>> Eric Schurenberg: Well that's a tough impulse to fight these days. I would think anyone who's had the market -- their money in the market for the past 18 months is really fighting the impulse to pull out. What's your advice? How do you convince yourself to stay aboard?
>> Harry Markowitz: If you're an individual and you're -- don't have a financial advisor to compute an efficient frontier and get a sophisticated mix of asset classes, you should have a broadly -- you should split your money between a broadly diversified portfolio of equities and then bonds or cash equivalents or something. And get a mixture that you're willing to live with.
>> Eric Schurenberg: Harry thank you for your insights. Thanks for joining us today.
>> Harry Markowitz: My pleasure.
>> Eric Schurenberg: I'm Eric Schurenberg for Moneywatch.com. Thanks for watching.
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