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Odds are that you’ve encountered modern portfolio theory before, even if you’ve never heard the term. It’s been a driving force behind investment advice for decades.
Briefly, modern portfolio theory is the idea that as you diversify your investments, you ensure that riskier investments are offset, at least to some degree, by more conservative ones, based on your risk tolerance.
In other words, an individual investment’s risk shouldn’t be viewed in a vacuum. It should be scrutinized based on how it fits into the portfolio’s overall risk and return. Before modern portfolio theory, investors tended to view each investment in isolation.
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This diversification strategy for the risk-averse is often expressed through the example of a 60/40 ratio — essentially, putting 60% of your investment money into stocks and 40% into bonds.
It sounds wise, but it does have its problems, and the time might have arrived to debunk modern portfolio theory and decide whether it’s right for you as an investor in 2026.
The theory’s limitations
Modern portfolio theory is not really that modern, as it’s been around since the early 1950s, when many of today’s retirees weren’t even born.
Economist Harry M. Markowitz developed the theory and went on to win the Nobel Prize, so there was significant brainpower behind the theory’s emergence.
But there was also a bias in the theory toward a risk-averse approach to investing, a strategy that comes with limitations for those with a higher risk tolerance and an eye toward gaining higher returns.
Consider that 60/40 ratio. The 40 side often concentrates on bonds, which don’t always perform well enough to offset inflation.
Essentially, the money on that side of the portfolio struggles to hold its value and, in a sense, might as well be sewn into a mattress or buried in a jar in the backyard, as far as the return on investment goes.
The theory on the international front
Modern portfolio theory also calls for adding a different kind of diversification — international flavor — to your investments.
Admittedly, the international market has done remarkably well in the last year or so, producing large returns for happy investors.
But that hasn’t held true throughout history — even recent history.
In the last 10 years, many of the international funds have posted returns around 9% or 10%, a respectable amount perhaps, but during that same period, the S&P 500 saw a return of about 15%, making it the better long-term investment.
The theory and those who aren’t risk-averse
Modern portfolio theory has its proponents who see it as a good way for investors to grow their money while trying to minimize the risk involved.
Since it also has its downsides, the theory has drawn its share of critics over the years. One problem with modern portfolio theory is the assumption about investors being risk-averse, as if that applies to everyone under all circumstances.
Modern portfolio theory seems to imagine a herd of cautious investors who prefer to balance nearly every stock purchase with a corresponding low- or no-risk investment to even things out.
Plenty of investors are risk-averse. People who are near or in retirement are often advised to reduce the risk in their portfolios even more than modern portfolio theory would call for.
This is because of the damage a major market decline could cause to their investments at a time in life when they might not have enough years ahead to recover from a crash.
Not every investor is so allergic to risk, and modern portfolio theory doesn’t take into account investors willing to take a more aggressive approach to investing to have a chance to reap the potential exorbitant rewards.
For them, a 60/40 portfolio might make little sense because they have limited interest in hedging their investment bets with a large sampling of bonds, CDs or whatever else might bring a portfolio in line with a more conservative approach.
Another problem with the theory is that it relies on the past performance of a stock to determine likely risks and returns. But history isn’t always a good indicator of what might happen in the future, especially when unexpected events occur, such as a pandemic, that can disrupt expectations.
The theory and your risk tolerance
Despite its history and general usefulness, modern portfolio theory doesn’t provide the answers for every investor in every circumstance.
This is among the reasons you need a financial professional who can measure your specific needs and attitudes toward investing to help you create a portfolio that matches them. Maybe that does mean a 60/40 mix, but it could also mean something very different.
An adviser can also help you determine your risk tolerance:
- Are you in line with what the theory anticipates, someone who wants to offset the aggressive investing in the stock markets with something more conservative on the other side?
- Are you someone who expects to be a more active trader, looking for opportunities to reap higher returns with the understanding that this approach comes with risks — and you’re fine with that?
Wherever you fall on the investing continuum, it’s important that you have a good understanding of what’s in your portfolio, the risks you’re taking and what your goals are for your money.
Ronnie Blair contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
