CHAPTER 12Prudent Investing with High‐Variance Assets: An Experimental Chapter
“Yeah man, they call gambling a disease, but it's the only disease where you can win a bunch of money.”
—Norm Macdonald
One of the most disconcerting results of goals‐based portfolio theory is that gambling is, at times, rational. I admit my own struggle with this result, and I have yet to implement a “gambling” portfolio with clients. Yet I cannot deny the mathematical and practical logic of the result—brutal intellectual honesty requires nothing less. Therefore, some treatment of the method for prudent investing using lottery‐like investments seems reasonable, even if its actual implementation is not yet feasible. I have included this chapter, then, as a sort of working document—a record of early thoughts on a topic that I see gaining credibility and consideration in the coming years. I would urge my fellow practitioners to read this chapter reluctantly and with extreme suspicion. And, as usual, do not take any of this as investment advice! This is all very experimental.
Let's quickly review the relevant points. Modern portfolio theory, and its goals‐based adaptations, generally assume no endpoint to the efficient frontier. This can only be true if (1) an investor can invest borrowed money without limit or cost, and (2) can sell securities short without limit or cost. Besides the fact that this is entirely unrealistic, this also creates a contradiction. If a goals‐based investor can borrow without ...
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