Face it, after reading about the 5^th Deadly Sin (see“7Deadly Sins Every ERISA Fiduciary Must Avoid: The 5th Deadly Sin –Misapplied Asset Allocation,” FiduciaryNews.com, June9, 2015), you knew this one was coming.

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Truth be told, we’ve been sitting on this for quite some time –almost two decades in fact. Why?

Because we didn’t feel the world was ready to handle the truth.We’re still kind of leery that we might be chased by angryvillagers with their pitchforks and torches. But we’re confident(with a bit of irony as you’ll see in a moment), rational mindswill prevail. (Of course, we have no such confidence when it comesto the 7^th Deadly Sin).

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What if everything we were taught about investment theory turnedout to be wrong? That’s the question on the cusp of being answeredin a new series of articles (see “7 Deadly Sins Every ERISA Fiduciary Must Avoid: The6th Deadly Sin – Not-So ‘Modern’ Portfolio Theory,”FiduciaryNews.com, September 7, 2016).

That Modern Portfolio Theory (MPT) is the subject of the DeadlySin series shouldn’t surprise many. There have been a growingnumber of articles in recent years attesting to the failure of thenearly three-generation-old theory.

A better question might be: Why have its failings been coveredup for so long? After all, as the above series explains, no soonerhad MPT become “generally accepted” than those paying attentionbegan to expose its failures.

If you’re a student of investing and regulators, you’ve alreadydiscovered there’s an awful tendency for government administratorsto lag behind. Just when the powers that be endorse something, thatsomething turns out to be not so great as previously thought.

By then, though, it’s become “too big to fail.” The industry hasentrenched itself into the new orthodoxy. It costs too much toswitch gears; thus, the inefficiency not only continues, but itgrows.

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There’s a lesson I remember from business school involving sunkcosts. It goes something like this: If you’re going to determinethe ROI on any particular marginal expenditure, the return must becalculated solely on that marginal expenditure.

You can’t include any previous investments, a.k.a., “sunkcosts.” If you pay attention to sunk costs, you might not makeinvestments you might otherwise make or you might not cut yourlosses before it’s too late.

For example, and this may be appropriate as the polls show Trumpbeginning to extend his lead, I recently spoke to someone who worksfor a major health insurance firm. With bad news on Obamacaremounting, I asked him how he thought the failing program would berepealed and replaced.

He quickly rebuffed the question, saying the law would never berepealed. I asked him, “Why?” His simple answer: His firm hadjust sunk millions of dollars developing systems for it over thelast few years.

In a phrase, it’s too big to fail. Too much money has beeninvested and we can’t let that money go to waste, can we? It’s thesame issue with MPT, and it explains why it’s taken so long forCaptain Obvious to open his mouth.

Who are these vested interests?

I have talked to many of the usual suspects from the world ofacademia. For the most part, the old guard – the ones who came upwith, promoted, and profited from MPT – remain its most ardentsupporters. They are the ones with the greatest sunk costs. Butthey’re not the ones doing ground-breaking research today.

The younger researchers don’t even seriously discuss MPT as aviable option. They realize it contains too many documented flaws.It’s just not the kind of thing you want to stake your professionalreputation on. They have no sunk costs in this decades-oldtheory.

So, who has the greatest sunk costs? Companies and individualsin the financial service industry have the greatest sunk costs.

From the firm point of view, just like my friend’s insurancecompany, they have invested far too much money in marketing,systems, and internal training to justify changing things.

From the individual point of view, if you’ve spent you’re entirecareer as a practitioner trained in all aspects of MPT, it’sdifficult to change tunes this late in the game. Besides, you’vegot the regulator’s cover of it being a “generally accepted”investment theory (current research aside).

There remain portions of MPT which continue to make sense. Forexample, the relationship between perceived risk and expectedreturns retains its logical underpinnings.

Once you start getting beyond that, though, things begin tounravel. Maybe it can predict, maybe it can’t. But you can sureshow people how it might, and you can get them to believe itwill.

In 1951, Harry Markowitz began working on the paper that wouldeventual evolve into Modern Portfolio Theory. That same year, inthe Third Edition of the seminal Security Analysis, BenGraham said, with eerie foresight, “We find these forwardprojections of the past to be misleading at least as often as theyare useful.”