Within the volatility, uncertainty and change happening throughout the financial services industry, there is a growing movement questioning and re-thinking everything about the investment process itself. Taking this changing mindset directly to retail investors is Leland Hevner, president and research director at the National Association of Online Investors - a leading investor education, investment research and financial consulting organization. Their mission is to empower individual investors to invest with confidence and to provide financial organizations with innovative investment solutions that will give them a distinct competitive advantage in the eyes of the public.

The Institute for Innovation Development believes his application of the proven innovation development tool of “Design Thinking” to the investing process - starting from the individual retail investor’s perspective - provides an excellent example of a structured process on how to rethink established investing practices. Financial professionals would be well advised to understand the research and client engagement process that he took, along with, the message he is bringing to individual investors and the industry at large.

Bill Hortz: Why do you feel investing today is dysfunctional?

Leland Hevner:  The field of investing is predominantly stuck in the past. We are told by many financial professionals, including most roboadvisors, that the only way to invest is by using a methodology called Modern Portfolio Theory (MPT). This is an approach to portfolio design that was introduced way back in 1952! Markets have changed significantly since then while MPT has barely changed at all, and it is no longer relevant to individual investor needs in today’s volatile, uncertain and stressful markets.

When the stock market crashed in 2008, I watched in dismay as the MPT portfolios, that I was teaching my students to create at that time, were crashing along with the market. At that point I paused all NAOI education efforts as I realized that more than education was needed to empower individuals to invest with confidence – also need was innovation in the form of a fundamentally different approach to investing.

Hortz: What, specifically, did you determine about Modern Portfolio Theory that doesn’t work?

Hevner:  First, MPT dictates that portfolios be designed to match the risk tolerance of each investor. The problem here is that determining a person’s risk tolerance is a massively subjective task and hard to quantify using traditional risk assessment methods that ask questions such as “If the stock market fell 10% in one week would you sell your stocks, buy more stocks or do nothing?” Most individual investors are not prepared, or fully think out, answers to questions like this. But, unfortunately, the answers to risk tolerance questionnaires determine a person’s portfolio design and, thus, their financial futures.

Second, the goal of MPT is wrong for modern markets. Instead of designing portfolios to meet the risk tolerance of individual investors, I believe that portfolios should be designed to produce maximum returns with minimum risk in all economic conditions. In other words, portfolios should be “market-sensitive” instead of “investor-sensitive”. By having the wrong goal, MPT methods produce static portfolios that neither enable investors to take full advantage of today’s dynamic markets nor protect them from major market downtrends.

Hortz: What first steps did you take in fixing those problems?

Hevner:  As to first steps, I didn’t start with the investment process as most of the industry does, I started by working with the people that the new investment process was meant to serve. I followed a modern innovation and R&D process called “Design Thinking” which forces you to challenge assumptions and create better ideas by keeping the customer continually involved in the development effort. The steps we used were:

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