Forget Facebook: Markowitz Stresses Diversification

Plenty of investors, motivated by greed and the media’s general hoopla, got caught up in the Facebook IPO frenzy. The result? Another big win for Wall Street. Days before the IPO, Facebook increased the number of shares it would offer to the public by 25 percent. Sure, this meant more hopeful investors could get in on the social media action, but, most significantly, it added to the wealth of Facebook founders and diluted the value of shares to be bought by retail investors. That’s how Wall Street rolls.

So, when Facebook closed its first day of trading, up only 23 cents, at $38.23, and disgruntled retail investors grumbled, investors who got in on Facebook’s ground floor and had sold shares all day were doing cartwheels.

Sometimes it takes a circus-like atmosphere to remind us that investing should be a long term, rationally-driven activity, not short-term speculation motivated by media hype and emotions.

Perhaps the most compelling reflection on the Facebook IPO came in an article written by Jeff Sommer “Before Leaping, Listen to a Giant.” The “giant” is Harry M. Markowitz, who, Sommer writes, “may have had a greater influence on current theories of finance and investing than any other living person.”

In the article, Sommer quotes Markowitz, the winner of the 1990 Nobel Prize in Economics and the Father of Modern Portfolio Theory, as saying, “Most people don’t need to think much about individual stocks. You can put yourself in a position to say, ho-hum: Facebook, JPMorgan, they may be up, they may be down — it doesn’t really matter.”

Markowitz’s advice to individual investors? Buy “broad low-cost stock and bond index funds instead” and allocate them in a proportion that gives you a level of volatility with which you are comfortable.” Where have you heard that before? Indexing may not have Facebook’s flash, but it’s more solid than ever in today’s volatile market. And diversifying your portfolio between stock and bond funds chosen in accordance with your risk tolerance and future goals will always be more prudent than plowing money into the latest hot stock.