Kevin O’Leary: If You Understand Modern Portfolio Theory, the Markets Will Treat You So Much Better
Not everyone agrees — because putting more money into your 40th best investment instead of your top choices might be riskier.
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Sometimes, luck and a mother’s tough love can make all the difference.
On Kevin O’Leary’s last day of college, his mom, Georgette Bookalam, said, “The dead bird under the nest never learned how to fly. It means Kevin, no more checks. I’ve done my work, and now you need to do yours”.
O’Leary replied, “That’s a great poem, Mom, but I need some cash. I don’t have a job, and I have no money.”
Kevin calls it the biggest kick-in-the-gut lesson he ever got because he was broke for years after.
When he told his kids that they, too, would get nothing the day they finished college, his son looked at him like he had lost his mind and said, “What do you mean I get nothing?”.
It’s all hinged on O’Leary’s philosophy that — “fear of the unknown could be avoided by finding a path. If you de-risk your children’s lives, you’re giving them a disease.”
“Mr Wonderful” is Kevin’s tongue-in-cheek nickname, and it’s a dig at his reputation for being mean, which came about from his blunt feedback of entrepreneurs on the U.S. show Shark Tank.
Like when he told one contestant who started crying, “Money doesn’t care. Your tears don’t add any value.” Lol.
I look beyond the tough persona of the serial investor and see a person fueled by the love of his late mother — it resonates with the relationship I had with my mother, who has also now passed.
But O’Leary also doesn’t shower himself in glory.
I’ve been following the guy with a $400 million net worth on Twitter for a few years, and one comment went down like a sh*t sandwich.
As soon I saw it, I thought, Kevin, what have you done here?
Kevin O’Leary — Source
“You may lose your wife, you may lose your dog, your mother may hate you. None of those things matter. What matters is that you achieve success and become free. Then you can do whatever you like.”
Aside from risking his career with a tweet and teaching his kids a high-risk, harsh love lesson, Mr Wonderful is far more risk-averse with his investments.
He says if you understand Modern Portfolio Theory, the markets will treat you far better.
Buckle up, and let’s dive in.
99% of Funds Follow This Approach
Kevin O’Leary recommends following the lead of 99% of Sovereign Wealth Funds by embracing Modern Portfolio Theory (MPT) when making investment decisions.
It’s a strategy that carries weight in the financial world but is a fancy way of saying, “Get diversified”.
Harry Markowitz, the American economist who came up with MPT (he passed away at 96 this year), was a big deal in shaping how investment portfolios work. His ideas earned him a Nobel Prize in Economics.
MPT aimed to achieve “lower volatility” based on the optimal combination of risky and less risky assets working in tandem.
It assumes you, as an investor, are risk-averse, meaning you prefer a less risky portfolio given the level of return.
You choose investments based on potential returns using historical performance, and then you create a diverse portfolio with varying risks and expected returns allocated to each asset.
You select a mix of non-correlated assets (different sectors) that matches your risk profile, giving you an “Optimal Ratio”.
It’s like finding the perfect blend of colours to create a painting to get the desired result.
The dots below represent the individual assets and where they are on the risk curve.
It’s a strategy O’Leary uses with all his investments.
He highlights MPT because, as he says, most investments typically fall into two categories: high risk with the potential for high returns or low risk with lower potential returns.
Mr Wonderful believes you can optimise your results by striking a balance between the two instead of putting all your eggs in one basket and relying solely on the performance of individual investments.
Mixing investments with varying levels of risk and return can create a more efficient portfolio.
KO says he gets diversified by never investing more than 20% of his capital in one sector and never more than 5% in a single stock.
Kevin Oleary — Source
“A major lesson I learned from my mother that worked for me over the years. She had a basic portfolio theory of diversification.
So, you only put up to 20% in any sector and never more than 5% in any stock.
That forces you to get diversified, and the market treats you better when you’re diversified because you never know what will happen.
I’m a diversified guy — I never have more than 5%. If a stock does become more than 5%, like my Tesla stock did, I simply sell it down to 5%. If it keeps going up, I keep selling it down, so I’m taking cash.”
Not everyone agrees — “It’s Twaddle.”
When you buy a business, you own a business.
Warren Buffett, one of the most successful investors, has an interesting perspective on MPT.
Alongside his long-time business partner Charlie Munger, they say MPT has led to a misguided direction in investment education over the past four decades.
The problem with all these theories is people are fixated on the numbers and data, losing sight of the bigger picture.
According to Buffett, volatility isn’t an accurate indicator of risk.
He points out that an investment with fluctuating returns between 20% and 80% isn’t necessarily riskier than one that consistently earns 5% annually.
Instead, Buffett defines risk as “the possibility of harm or financial injury.”
He stresses the significance of knowing the core aspects of a business instead of solely focusing on graphs and numbers and playfully describes this method as “enlightened common sense.”
Warren Buffett — Source
“Much of what is taught in modern corporate finance courses is twaddle.
Modern portfolio theory has no utility. It will tell you how to do average, but I think anybody can figure out how to do average in fifth grade.
It’s elaborate, and there are many little Greek letters and all kinds of things to make you feel that you’re in the big leagues, but no value is added.
If you find three wonderful businesses in your life, you’ll get very rich. And if you understand them, bad things aren’t going to happen to those three.”
Final Thoughts.
If you don’t understand businesses and how they work, Kevin O’Leary’s passive diversification argument has merit, but MPT is still a theory and doesn’t prevent risk.
It also prevents you from investing more in your highest conviction investments by spreading yourself too thin.
If you’re one of the “little guys and girls” like us, you want every dollar to pack the punch of ten.
Maximum penetration in a small number of high-conviction investments in businesses you understand.
Not only might you find the best result, but reasonable logic when your investment inevitably drops in price.
Take Gary Vaynerchuk’s investing story, where he earned $50,000 a year, managed over a decade to save $200,000, and invested it all into Facebook, Twitter (pre-IPO) and Tumblr before he even knew what angel investing was.
He’s a marketer who saw the advertising opportunity on those platforms because he understood “consumer attention” and that advertisers would flock to where the attention was.
And they did.
The simplicity of it almost makes you want to take your shoe off and slap yourself with it.
Ultimately, deciding which approach best aligns with your goals and risk tolerance is up to you.
But as Buffett says profoundly, and it’s a statement I agree with — “Diversification into a wide range of investments is a confession that you don’t really understand the business that you own”.
Warren Buffett — Source
“You know, we think diversification — as practised generally — makes very little sense for anyone who knows what they’re doing — it protects against ignorance.
If you want to ensure nothing bad happens to you relative to the market and only ever achieve average results, maybe it’s a perfectly sound approach.”
If you’re unsure what you’re investing in — maybe that’s the risky part.