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Originally Posted by pelagius
I don't won't to be too hard on people but I guess I would also emphasize that what most people call portfolio theory really isn't. Its stuff that builds on top of portfolio theory.
Really, the primary implication of portfolio theory is that optimal portfolios can be described as follows: an optimal portfolio has the highest expected return given the desired standard deviation of an investor. If someone believes that the risk of their portfolio is captured by standard deviation then portfolio theory is the right framework (yes, one can argue that standard deviation is not a good measure of risk and that is another potential shortcoming of portfolio theory). Portfolio theory provides a framework for thinking about what optimal portfolios look like. An optimal portfolio doesn't necessarily have 1000s of securities in it (although under certain assumptions it always does). An optimal portfolio can have only one stock in it.
Warren Buffet, for example, often says he doesn't follow the implications of portfolio theory. This is true in the sense that he doesn't follow the implications of portfolio theory as often presented to undergraduate students or MBAs. However, I have seen nothing from Buffet that is inconsistent with the idea that he his creating a portfolio that for a given level of standard deviation has the highest expected return possible. He just believes that the expected returns, variances, and covariances that he observes are different than and superior to other people's estimates (note, this implies that his optimal portfolio may look very different than mine even if we have the same preferences for risk and both may be consistent with portfolio theory). Portfolio theory allows for such differences (complete agreement and market efficiency are imposed in models like the CAPM that build on portfolio theory). Buffet's portfolio may be optimal or statistically indistinguishable from optimal (in the full sense of modern portfolio theory) given his estimates and taking into account parameter uncertainty, transaction costs, price impact, etc.
P.S.
These issues aside I generally think that Jay gives pretty good advice when it comes to portfolio allocation ... he may not always be diplomatic ... but his advice is pretty sensible.
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What would be interesting would be to take Jay's breakdown, 50% domestic, 30% international, 10% RE and commodities and 10% bonds. Take randomly 3 10 year periods and 20 year periods and compare the return to a good equity manager who claims to beat the S&P by 2-3 percent. My guess would be the numbers wouldn't be that much different, especially over the 20 year period.
Either method is fine as long as the results are good. Go through the mental girations and follow the formula or find someone who is getting results and just let them manage the money for a fee.