Chapter 5. The Market Portfolio Is the Benchmark

The key lesson of more than half a century of investment research is clear: diversify within and across the major asset classes. To the extent there's consensus in strategic investment ideas, it ends there, giving way to the great question that animates much of the debate about building and managing portfolios: how should we implement and manage a policy of diversification? For some investors that evolves into the question of which asset classes to hold or exclude. Beyond that, how should we weight the various asset classes? And how much and how often should we adjust the asset allocation?

There's no easy solution, nor is there likely to be one. The capital and commodity markets are resistant to the idea that an enduring truth will give us a silver-bullet answer to everyone's basic quest to earn above-average returns now and forever more. There can be no strategic solution that offers a guarantee of success for everyone at all times. The relentless feedback loop of risk and return is forever changing equilibrium prices and perceptions about what constitutes prudent discounting of expected events. The market's main output is price, which changes through time. The internal processing system that creates and modifies prices is largely a black box. Thanks to fifty years of research, it's less of a black box in the twenty-first century, but the mysteries of how the capital and commodity markets operate still overwhelm the thin sliver of ...

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