Nobel Prize Winner Harry Markowitz Answers Your Top Ten Questions about Money

in Financial Planning by

KEY POINTS
  • Nobel Winning Harry Markowitz offers his two cents on saving money.
  • Markowitz shares his pro tips on interest rates, retiring, and keeping cash in the bank.
  • Markowitz explains you should rethink how you prepare your kids financially.

Have you ever wondered how a Nobel Prize winner in economic sciences manages his money? When I got the chance to speak with Harry Markowitz (who is a 1990 Nobel Prize laureate, recognized as the “Father of Modern Portfolio Theory”, and a 1989 John von Neumann Theory Prize recipient), I was wondering just that. You may have heard that Markowitz recently joined Personal Capital’s Academic Advisory Board, and we can say we’re thrilled to have him on board to help us design new, innovative solutions to help American households make better financial decisions and save for retirement.

Recently I sat down with Harry to ask him how he manages his money, and what advice he can give Americans about living their best financial lives. Read on to find out how he answers your top 10 questions about money:

1. What are the top pieces of advice you give people about money?

Markowitz: I only have one piece of advice. Diversify. And if I had to offer a second piece of advice, it would be: Remember that the future will not necessarily be like the past. Therefore we should diversify.

2. What are your thoughts on the rising number of students graduating with debt, and is there anything we can do about it?

Markowitz: My answer to this is that when you get a Nobel Prize, people think you know everything. My work is focused on the benefits of diversification, which cannot be applied directly to the student loan debt question. I have personal opinions about it of course, but I can’t claim to be an expert on the matter.

3. What is the best way for first time investors to get started?

Markowitz: Finding a financial advisor is a great first step. But, if you’re a first time investor and cannot afford a good personal advisor, then you should start by splitting your funds between a well diversified stock portfolio and a savings account. The ratio of the split will depend on your age – young people should have some savings for liquidity, but could be invested almost entirely in stocks if they want.

It’s also important to know your risk tolerance. If you’re young and heavily invested in stocks, for example, make sure that you’re not so invested that if the market declines 30%, you’ll chicken out of investing in stocks altogether.

4. What is the biggest personal financial challenge you have faced throughout your life?

Markowitz: I’m cautious, I started investing early, and I don’t bother to trade, so I can’t say I’ve run into too many challenges! I lost some money on a condo at one point, but that wasn’t too bad. Overall, I think speculating too much can become a challenge for many people, so I try to avoid that because I’m more of a chicken. Take economist John Maynard Keynes, for example. He was a speculator, which made him rich and then poor and then rich and back to poor again, over and over.

5. What are your thoughts on today’s low interest rate environment and the implications on your portfolio?

Markowitz: Obviously interest rates are going to go up over the few next years, but we don’t know exactly how fast.

Personally, I have bonds in my retirement account, municipal bonds in my other accounts, and cash accumulated as well. I also have equities in my taxable accounts. I accumulate cash for when interest rates are at a more normal level.

6. What is the role of fixed income in a historically low interest rate environment?

Markowitz: You have to decide your risk tolerance (given your age), and how much your portfolio could decline in value before you get scared and decide, “To hell with it, I’m getting out!” Suppose that stocks could go down 40% in a really bad year, and you know you’ll get scared if they go down more than 20% – then you know you should be half in cash or other fixed income. We all know there is a risk-return tradeoff, and you have to decide how much risk you’ll incur and stick to your financial plan.

If you’re young and your human capital is large, however, it’s perfectly fine for you to be 100% invested in stocks, because your fixed income is, more or less, your human capital.

7. How do you decide how much cash you should keep in your bank account (vs. what to invest)?

Markowitz: Usually, you should use cash for liquidity purposes. If you have a business (like I do), for example, you need cash to be able to pay your bills if your income declines. There are a lot of different schools of thought on how much cash you should keep in your accounts for emergency purposes. My rule of thumb has been at least three months of gross income plus enough to pay imminent estimated taxes. So far, my income from my consulting work has luckily never declined.

8. How do you think about working later in life vs. retiring?

Markowitz: I’m 88, and I love my work. Whether you work later in life or retire early is an individual decision.

Suppose you worked in an office job your entire life, but you always really wanted to open a restaurant. When you retire, you have a chance to open that restaurant! That’s what I would do, because if you don’t move you rust. If you’re really lucky, you’ll find ways to get paid to do the things you find fun anyway (like my work with Personal Capital).

9. What do you think are the most important financial considerations for retirees?

Markowitz: Well, you have to remember that you don’t know how long you’re going to live. Simulation analysis of possible scenarios is one place where operations research can be of help. You need to know what the trade-offs would be if you live longer or shorter than you expect. If you spend your retirement savings too fast, you’ll be in trouble. But if, on the other hand, you spend very little and leave a big estate when you die, maybe you could have afforded to spend a little more.

The problem is that such simulation analysis is not a do-it-yourself thing. As a rule of thumb, I recommend taking a look at a mortality table, and then give yourself a few more years than that to be safe. You have to redo this calculation every couple of years or so.

10. What’s the best way to teach your kids about finance?

Markowitz: Teaching your kids about budget constraints is crucial. I have four children, and the only teaching I did to my children about finance when they were growing up was to give them an allowance. They couldn’t just buy anything they wanted, and through that lesson they learned the value of money.

When we took family trips to Sea World or Disney Land, for example, I’d give them each a certain amount that they could spend in the gift shops. If they hadn’t been used to the idea of a budget, I think they would have gone for the most expensive things in the shops. But because they learned to have a budget constraint, they learned to be thoughtful about the things they bought.

Managing Your Money

We’re excited to have Markowitz on Personal Capital’s Academic Advisory Board, and we hope his sage advice will help you along your financial path. And if you need any help, remember our advisors are only a free financial consultation away!

Get Your Free Financial Consultation

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Marianne Ahlmann

Marianne Ahlmann

Marianne is Communications and Content Manager at Personal Capital.

5 comments

  1. JD Wrecks

    Wonderful little interview with a great man. I especially liked the part about “when you get a Nobel Prize, people think you know everything”. Are you listening, Dr. Krugman?

    Reply
    • Joey Fredrick

      Very helpful information. My wife and I are young newlyweds and I’m considering how we should structure our portfolio. We definitely can’t afford an advisor so we have to do our research. Great info! Thanks PC!

      Reply
    • Kelly

      Dr. Krugman must have really gotten under your skin. The truth tends to do that!

      Reply
  2. Tom

    I learned from Dave Ramsey that instead of giving our kids allowance which in some way is similar to entitlement, we give our kids commission for doing specific household chores. That way, they appreciate whatever they purchase more than ever and learn about budgeting at the same time. It’s a win-win for both parents and kids.

    Reply
  3. Ed Smith

    Well, far be it from me to question a Nobel winner; but, it would have been terrible advise indeed over the past 15 years to accumulate cash in hope that some day interest rates will go higher. The comment was

    “Personally, I have bonds in my retirement account, municipal bonds in my other accounts, and cash accumulated as well. I also have equities in my taxable accounts. I accumulate cash for when interest rates are at a more normal level.”

    Reply

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