The world lost a true investing legend recently when Harry Markowitz passed away at the wise old age of 95. Markowitz is widely known as the father of modern portfolio theory, and it’s impossible to overstate his significance not only to my own outlook on investing but also to the entire modern industry of portfolio management. He was a good man and a brilliant thinker, and his unique insights will continue to influence us for a very long time.
Who Is Harry Markowitz?
Markowitz is best known for his PhD dissertation in 1952, humbly titled “Portfolio Selection”, where he convincingly argued that the risk of a portfolio is less about the behavior of individual components and more about how multiple parts all relate to one another. A portfolio with multiple volatile assets can actually have lower volatility than any one asset in isolation. And by studying different combinations, one can find the most efficient option for a person’s given needs.
If that sounds a little hard to grasp, don’t beat yourself up. Until Markowitz came along, the brightest minds in finance pretty much all agreed that the best stock market strategy was to study individual companies and pick the handful that you felt had the best profit prospects. But one day while reading an investment book by economist John Burr Williams, Markowitz intuitively felt that something was wrong. Here’s the story in his own words:
“Williams proposed that the value of a stock should equal the present value of its future dividends. Since future dividends are uncertain, I interpreted Williams’s proposal to be to value a stock by its expected future dividends… This, I knew, was not the way investors did or should act. Investors diversify because they are concerned with risk as well as return.”
Harry Markowitz, Nobel biography
Basically, while other economists were busy evaluating individual companies from a theoretical perspective, Markowitz saw something deeper from a practical, everyday mindset. Investors aren’t all economics professors. They care about risk. And evaluating the risk of a portfolio requires looking at things beyond projecting expected future dividends of each company.
Once he started digging, a whole new financial paradigm emerged. If you’ve ever read about efficient frontiers, that’s Markowitz’s idea. Modern portfolio theory is just shorthand for his framework for evaluating how multiple uncorrelated assets work together. Other keystone financial concepts like the capital asset pricing model (CAPM) were built on the foundation that he laid. And his ideas about looking at the big picture and selecting the most efficient portfolio for your personal level of risk set the standard for decades of financial advisers to follow.
He was so impactful, in fact, that Markowitz eventually won the Nobel Prize in economic science in 1990 for his contributions to how we all understand investing. As I said, he’s a legend.
Beyond the Theory
Amid all of his well-deserved accolades, I think the things I respect the most about Markowitz are his humanity, conviction, and willingness to think differently.
I mean sure, his economic theories were genius and are so widespread today that they’re probably taken for granted. But at the time that he first wrote about them, he was definitely the oddball in the group. So if you want to unpack why his ideas were so revolutionary, think for a moment about the environment they came from.
First, picture in your mind a room full of young economics graduate students at the University of Chicago toiling for hours in the library reading treatises on financial models, debating economic metrics, and desperately seeking the approval of their famous professors like Milton Friedman. That cloistered environment is self-selecting and develops a certain type, and I imagine that’s not how you also picture the average guy his age.
Now, think about what Markowitz did. When reading the best theories of the day recommended by his professors, he didn’t just accept them at face value and take the easy route to a paper that flattered the dissertation committee. I like to picture him leaving the dark and dusty hidden corner in the book stack, squinting his eyes as he opened the door to walk outside, and realizing that — you know what? — real people outside of economics departments don’t actually make decisions this way. There has to be more to the story.
Challenging convention is no ordinary act, especially in the most respected academic circles where authority is a big deal. When Markowitz later defended his dissertation, it’s reported that Friedman dryly replied that “We cannot award you a Ph.D. in economics for a dissertation that is not economics.” Friedman was of course just yanking his chain, and Dr. Markowitz got the degree and accolades he more than deserved.
But all jokes aside, Markowitz later admitted that he believed in the moment Friedman was completely serious. No matter how confident he was in his convictions, he had indeed challenged the authority of the greatest economic minds in favor of viewing markets not in terms of stoic academic absolutes but from the perspective of blurry human nature. What made him special was not simply that he was smart and well-read. He understood people.
For that reason and more, Markowitz will always be remembered not just as the father of modern portfolio theory but as a pioneer in the field of behavioral finance. Yes, he was a brilliant economist and mathematician who also contributed some impressive practical products like SIMSCRIPT. But he was also an insightful man who thought beyond the textbooks and who dragged the financial world into an exciting new place that accounts for the personal thought processes of millions of normal people like you and me.
Harry Markowitz had a huge impact on investing. His ideas are arguably the core foundation that Portfolio Charts is built upon. And his story inspires me to this day.
I never had the pleasure of meeting Harry. But I’ll miss him nonetheless.
Additional Reading
For more information on Harry Markowitz, his life, and his ideas, these are worth your time.
Harry Markowitz, Nobel-Winning Pioneer of Modern Portfolio Theory, Dies at 95 — The New York Times
A wonderful obituary suiting a remarkable man, and the inspiration for several anecdotes in this post.
Harry Markowitz’s Modern Portfolio Theory: The Efficient Frontier — GuidedChoice
A nice explanation of modern portfolio theory, efficient frontiers, and Harry’s investing perspective. Note that Markowitz was a co-founder and served on their investment committee.
IDEaS: Nobel Laureate Harry M. Markowitz — University of California Television
An educational video lecture where Markowitz explains his ideas in his own words. Pay attention not only to his points but also to his personality. This is an economics god quoting Shakespeare and Robert Lewis Stevenson with a smile. There’s no bluster, just genuine knowledge from a man you’d be happy to invite to dinner.
What is your favorite Markowitz insight?
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