Investors have neither an infinite time horizon nor infinite patience, which raises questions about the practical aspects of holding the market portfolio.
The unmanaged global market portfolio is a compelling benchmark of available risk premia, but as a real-world investment strategy, it's destined to run into challenges in the short run. The problem starts with the recognition that the market portfolio is probably ill suited to every investor's specific investment needs and risk profile. Another complication is the fact that risk premia vary through time, implying that investors can and should take advantage of the ebb and flow of market cycles by reassembling the market portfolio's asset allocation to build a customized strategy.
Yet we must be careful not to assume this is easy or that success is assured. For those who deviate from this benchmark, the risk of falling short of the market portfolio—perhaps far short—always looms, and the hazard grows as the time horizon lengthens. In the long run, outperforming the market portfolio is difficult, as suggested by the mediocre returns of active managers generally. Nonetheless, this is a risk worth taking for most strategic-minded investors, assuming we proceed intelligently by limiting our second-guessing of the market portfolio's asset allocation to those times and asset classes when the odds appear to be in our favor.
We start by considering the playing field: the market ...