I have been a fan of Monte Carlo and Ben Stein for most of my adult life.  How can you resist either of these two?  One aided in the creation of the atomic bomb and the other is an economist, author, game show host and movie star.  All right, so one has contributed in a more positive way than the other, but if you're not exactly familiar, Monte Carlo is a method that draws an outcome based on a defined set of inputs where it is impossible to compute an exact result.  So an easy example here is, what is the Dow Jones going to return this year?  Will it return 1000%?  I don't think so.  Using Monte Carlo, you can take prior returns and speculate what a future return might be.  This concept is the cornerstone of the book.

They begin by taking the Modern Portfolio Theory and picking apart its pieces.  They take a simple 60/40 stock/bond allocation and run it through their Monte Carlo tool to analyze the historical returns and what the projected likely returns might be over the next 1-3 years with this allocation.  No surprise, it's dull and boring and resembles the past since the standard deviation of this type of portfolio is low.  This is the starting point for the remainder of the book and the idea here is, how does one increase return while keeping risk reasonable.  A very important point was made here.  Most people compare their returns and turn a blind eye to the risk they've taken on to obtain those returns.  If you've bought a bunch of biotechs and eeked out a bit more of a gain than your grandmother's bond porfolio, were you properly compensated for your risk?  This is the second item they pay attention to.  Risk is measured via stand deviation.  While I don't necessarily agree that standard deviation = risk, I guess it's better than nothing.  I would be more apt to measure absolute risk in terms of drawdown.  But I digress.  So maximum returns for lower risk is the goal.  A noble one at that.

They proceed by taking various ETFs from various asset classes.  Small cap, emerging markets, commodities, Japan.  They demonstrate that more diversification will equal better returns with less standard deviation.  Nothing completely earth shattering here.  They do make a couple of things clear.  Simple diversification is not enough.  Just adding commodities or Japan to your portfolio is not a free lunch.  Over time, these assets have underperformed most of the world.  Having underperforming assets may lower your standard deviation but will also lower your return.  At this point, I could see where the book was going.  How do you make sure you have diversified, performing assets in your portfolio ... why picking "good" stocks of course.  Duh!

The book spent a number of pages telling us why none of us can be good stock pickers.  I tend to agree with them to a certain extent.  I don't think there are any magic formulas.  There are probabilities just like our good friend Monte Carlo tells us.  However, this is not a guarantee, merely an educated guess based on historical returns.  So to me this is either a huge contradiction or it is implied that Monte Carlo makes us better stock pickers.

Using individual stock picks is taken one step further.  As everyone knows, bonds introduce stability at the cost of lower returns.  This was also a real drag on the portfolio.  So how do you increase returns without increasing risk?  Introduce low volatility, high yielding stocks in place of bonds.  So now ETFs and bonds are removed or dramatically reduced.  We've come full circle from not being able to stock pick to having a portfolio nearly full of stocks.  I'm confused.

This book feels a lot like my first foray into backtesting.  You can find a system, introduce some handpicked stocks and tweak and tweak until the results look a bit too good to be true.  There are numerous pages dedicated to adding and tweaking until the R/R looks good.  Just like backtesting trading systems, if the past holds up, these are fine picks for the portfolio.  If they revert to mean, meaning these low volatility stocks become more in line with the broader market, you can bet that they'll make up for lost time.  The author's mention this possibility, but I think this is more than just a chink in the armor of the concept.  This can give you the exact opposite results that you were expecting.

Rebalancing is talked about briefly and an interesting idea is presented.  Rebalancing is bad, and the more you do, the worse it is.  In fact, never rebalancing your asset allocation seems to yield the best results, according to our authors.  Again this is something that's a bit worrisome as a blanket statement.  Couple this with single stock risk, never selling could introduce some heavy losses.  It also doesn't mention what to do with new funds.  If we're not rebalancing, then where do new funds go?  Because this is effectively rebalancing.  I think this idea of never rebalancing might be too much of a good thing.  I think excessive rebalancing is bad, but never, ever rebalancing may be bad as well.  Again, it depends on the selection.  If you bought Microsoft in 1986, rebalancing your gain each year would've made you a fool.  If you did the same to the Nasdaq in 2000, you'd be a genius.  These are two extreme cases to prove a point.

There were a number of concepts to take from this book.  Understanding the risk/return relationship is the big one.  Also taking historical performance of asset classes and analyzing why they behave the way they do.  A good example of this is small cap value outperforming large cap growth stocks.  Finally, being able to take a look at and construct your portfolio or long term holdings using assumptions based in reality instead of gut feelings, emotion or hot stock tips from your cab driver.

An point unrelated to the actual content of the book is that it is well written much like other Stein and DeMuth books.  The humorous tone keeps an otherwise dry topic entertaining.  Every book I've read from this dynamic duo turns out to be finished in a single day because I can't put the thing down.  This book was no exception.  I don't think any author expects everyone to fully agree with all of the ideas in their book, but the biggest item to take away from this is some new ideas and ways to approach things.  There are a number of departures from conventional wisdom that are worth exploring further.

There are a number of ideas in this book that may have merit.  If you're looking to build a portfolio of individual stocks or even ETFs, this book is worth it, especially if you don't really have a plan on how to go about it.  Also, if you're a traditional modern portfolio guy or a feisty rebalancer, this book really sheds some light on these approaches.  If you're a beginner to using a Monte Carlo tool on your portfolio, I also recommend this book.  It introduces some of the very basics and also explains how inputs changes the various outputs.