School is back in session, and in honor of that, theMotley Fool Answersduo ofAlison Southwick and former middle-school teacher Robert Brokamp are taking you back to the classroom -- virtually speaking.In this segment, we have a lesson about the evolution of the word portfolio.
A full transcript follows the video.
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This podcast was recorded on Sept. 13, 2016
Alison Southwick:The first class -- first period -- is English. And that's me. I'm your teacher.
Robert Brokamp:Yeah! All right. I'm seated. I'm listening. I've got my pen ready.
Southwick:You're seated and listening. So today for English class we're going to do etymology, and we're going to look at the origins of the word "portfolio."
Brokamp:Really! OK. Go right ahead.
Southwick:So portfolio, in finance, means your collection of investments and financial assets. It comes from (probably not surprisingly) the idea of the suitcase -- the portfolio suitcase. It comes from Italian as early as 1722 from the wordportafoglio...
Southwick:...portameaning to carry andfogliofrom Latin, meaning sheet or leaf. It's literally a way to carry your sheets of paper.
Southwick:Now, it wasn't until the 1930s that the word portfolio started meaning the scope of responsibilities for a job. If you were in a government office, you would say, "Well, it's not part of your portfolio. It's not part of your job." It wasn't until the 1930s that people actually started using portfolio to mean a collection of securities, but it still wasn't widely used, nor was the theory behind portfolio like it is today.
Brokamp:Oh, that's interesting.
Southwick:Well, just wait for it, because it's going to get more interesting.
Brokamp:Oh, it's getting even better.
Southwick:So back then (in the 1930s), when people created a portfolio, it was based on finding a good stock and buying it at the best price. I mean, that's not bad in theory, but the problem was this was in the 1930s, and all of the information about a stock was based on gossip, whispers, hearsay...
Brokamp:That's exactly right.
Southwick:...and a very slow ticker tape machine. According toInvestopedia, at the time investing was perceived largely as a "form of gambling for people too wealthy or too haughty to show their faces at the track." That's a quote fromInvestopedia.Way to be cute,Investopedia.
The term really took off in finance due to a 25-year-old grad student -- maybe you've heard of him -- Harry Markowitz.
Brokamp:I got an email from him once, but keep going.
Southwick:You did? He's a Nobel Prize winner.
Southwick:Oh, my gosh.
Brokamp:I wrote an article about him when he turned 80. I sent it to him and he sent me an email back. It was kind of cool.
Southwick:Aw! So you're probably going to know a lot about what I'm going to talk about from this point. Markowitz is dubbed the father of the "modern portfolio theory," also known as MPT. And even though he didn't have a background in finance, he was fascinated by the economics of uncertainty, which is basically the stock market when we're talking about the economics of uncertainty.
He thought it was cuckoo how nobody was worried about risk when it came to building a portfolio, and even in the 1950s, when he wrote his doctoral thesis, "Portfolio Selection," people only cared about buying a smattering of stocks that they thought were bargains.
So he thought what you should do (instead of just buying a bunch of random stocks, bonds, etc. that you thought were a great price) was to reduce your risk while seeing the same returns, and you do that by deliberately offsetting high-risk return things like stocks with low-risk, low-return investments like bonds. Basically diversification.
Southwick:And now the words "diversified" and "portfolio" pretty much go hand in hand.
Brokamp:Right. It's kind of crazy, because it's almost a given, nowadays, but back then it was this new concept, and he won a Nobel Prize for coming up with the idea of diversification.
Southwick:He also proposed that once you knew your risk tolerance, you could just plug the right investments in. I don't know if you knew this, but his paper, "Portfolio Selection," didn't blow people out of the water immediately, mostly because four out of the 14 pages were text -- only four. The other 10 were graphs and numerical doodles, which sounds whimsical, but it probably wasn't. It was probably a lot of sweeping equations. But the way they described it onInvestopedia,I thought was adorable.
Eventually his dissertation took off, since we all know the word portfolio today, and the term skyrocketed in the late 1950s and 1960s. If you look it up on Google (you can look up trends in literature), right after the late 1950s or early 1960s, the term for portfolio just skyrocketed. There you go. From suitcase for carrying your papers in Italy -- the portafoglio(that doesn't sound like Italian at all)...
Brokamp:That sounds great. That sounds awesome.
Southwick:...to the modern portfolio theory, or MPT.
Brokamp:That's really interesting.
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