Think of it as the ultimate in diversification: Your clients own what all other investors collectively own. This is the so-called market portfolio, a representative slice of the investable universe.

The market portfolio includes U.S. stocks, and also foreign shares, bonds and every other investment owned by the world’s investors, with each holding weighted by its market value. In effect, by buying the market portfolio, we can piggyback on the collective judgment of all other investors.

The market portfolio plays a starring role in Modern Portfolio Theory, which grew out of the work of such famed economists as Harry Markowitz, James Tobin and William Sharpe, all of whom won the Nobel Memorial Prize in Economic Sciences.

According to the theory, the market portfolio is the investment mix that offers the highest expected risk-adjusted return. What does it look like? According to a 2014 study in the Financial Analysts Journal, it consists of 55% bonds, 36% stocks, 5% commercial real estate and 4% private equity.

I think the market portfolio is an intriguing notion. But in all likelihood, your clients should own a somewhat different investment mix — for four reasons:


Based on that 2014 study, offers a ready-to-go portfolio of 15 ETFs called the CWM Global Market folio. Roughly half the portfolio is invested in the U.S. and half abroad. Almost 80% is in four ETFs that offer broad exposure to U.S. and foreign stocks and bonds, and those four ETFs cost a modest 0.05% to 0.19% a year.

But the portfolio also includes stakes in funds that own U.S. and foreign REITs, high-yield bonds, gold and other smaller segments of the market. ETFs in these more exotic market sectors face less competition, so they often charge steeper expenses.

For instance, the CWM folio includes stakes in SPDR Citi International Government Inflation-Protected Bond ETF, which charges 0.5% a year, and Market Vectors J.P. Morgan EM Local Currency Bond ETF, which costs 0.47%. Another holding, PowerShares Global Listed Private Equity Portfolio, levies 0.64% a year (and even more if you include the 1.45% in “acquired expenses” from the investment companies it invests in). The problem is, once you layer these costs on top of an advisor’s own fee, the odds that clients will earn decent returns get a whole lot slimmer.

My advice: If you buy the market portfolio, skip any ETF that charges more than 0.25% a year.


While retirees might mimic the market portfolio and keep 55% in bonds, most clients should have far less in bonds and much more in stocks. According to academic theory, that’s not a problem: Your working-age clients could still own the market portfolio, but they could buy it on margin.

In practice, this advice just doesn’t work, for two key reasons. First, most investors are leery of leveraging up their portfolio with borrowed money, and rightly so. In a steep market decline, they could be forced to sell at the worst possible time if their holdings fall below their brokerage firm’s margin requirement.

Second, investors will find it tough to borrow at interest rates that are below the yield on high-quality bonds. That means that for the bond portion of the portfolio, leverage will work against investors as they borrow at high interest rates to invest at low yields. If investors want to take more risk than the market portfolio, it would make more sense to keep less in bonds and more in stocks.

In fact, your younger clients might keep as little as 10% in bonds. The reason: They effectively already have a huge position in bonds due to the income generated by their “human capital.” You can think of a regular paycheck as comparable to the steady income from a bond portfolio. Because of the earned income from their “human capital” bond, working-age clients don’t need regular income from their portfolio.


Half the market portfolio is invested abroad, which might be palatable for younger clients with a high tolerance for risk. But for those near or in retirement, that sort of allocation wouldn’t be prudent.

Why not? U.S. retirees will spend most of their savings on U.S. early-bird specials, U.S. nursing homes and other U.S. goods and services. To match their assets with these liabilities, retirees ought to be leery of taking too much currency risk and instead should keep the bulk of their portfolio in dollar-denominated investments.

My preference is to do that by investing a bond portfolio largely or entirely in U.S. bonds, because that’s where retirees are likely to turn if they need money in a hurry. Let’s say a retired couple has 50% in stocks and 50% in bonds. The stock portion might be 40% in foreign shares, while the bond portion is invested entirely in U.S. securities. The overall portfolio would have just 20% exposure to foreign markets, which seems reasonable for a retiree living in the U.S.


Many investors should have far more in stocks than the market portfolio suggests. But you may have some clients who already have more than enough saved for retirement. Arguably, these clients should take less risk than the market portfolio, even if they have a high tolerance for market gyrations. As author and widely followed investment advisor William Bernstein has written, “When you’ve won the game, stop playing.”

If you have enough to pay for your goals, why continue to take a lot of risk? To be sure, if clients continue to hold a relatively aggressive portfolio, they might amass more wealth, which they could potentially bequeath to their children or give to charity.

But with that chance of greater wealth comes a risk of spectacular failure. We get just one shot at retirement. Making a lot of money would be nice — but losing a lot of money would be a disaster.

Jonathan Clements, a Financial Planning columnist in New York, is a former personal finance columnist for The Wall Street Journal. He’s the author of Jonathan Clements Money Guide 2016, as well as the new How to Think About Money. He’s also former director of financial education at Citi Personal Wealth Management. Follow him on Twitter at @ClementsMoney.

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