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Module 1 Lecture Slides
Module 1 Lecture Slides
Course Introduction
• Look at what happened in Detroit and other cities that went bankrupt
• Auto workers at GM and Chrysler
• Puerto Rico
• Pension plans don’t make the risk go away, they just handle it at a
higher level, and if the money isn’t there when you retire, it just isn’t
there
Now in the Era of Personal Responsibility
• Nice to see all your assets at once, move money around freely, invest with
just a click or two
• Crucial to save intelligently for retirement
• Propose an investment plan, help you stick to it
• Show you the range of outcomes you can expect
In This Module
• The founding father of portfolio optimization is still with us, his name is
Harry Markowitz
• Won the Nobel prize in 1990 for work he did in the 1950s
• His insight is the engine of robo-advising
• How to take the least risk for the expected return
Fundamental Axioms of Economics
Enjoyment
Money
Risk Aversion
• Give a choice
• Thousand dollars for sure
• Half chance of zero, half chance of two thousand dollars
• Expected value is the same
• But decreasing marginal utility pushes us to the sure thing
• More utility from the first thousand than from the second
Certainty Equivalent
• Expected return
• A probability weighted average
• Risk
• Variance – statistical measure of return dispersion
• Standard deviation – the square root of the variance
• For given expected return, choose the portfolio with minimum variance, or
standard deviation
Efficient Portfolios
• Mutual funds
• Exchange Traded Funds, (ETFs)
Mutual Funds
• Notice what these funds do, and don’t do, for you
• Fund will rebalance your investment for you
• Start out risky, tilt toward lower risk
• That’s it
• Not targeting a particular ending balance
• Some confusion about this during the financial crisis
Tilting from Stocks to Bonds