By Daniel Kanzler and Jakob Riemensperger
What is a “world portfolio” actually? Anyone involved in passive investing in German-speaking countries will sooner or later come across the term “world portfolio”, which Dr. Gerd Kommer introduced a good 20 years ago. But what is it all about actually? What does a world portfolio look like in concrete terms? And do you need one too? You can find answers to these questions here in this blog post.
Before we get started, let’s start with the terminology: The world portfolio is not a single, specific portfolio of specific ETFs or indices, but a portfolio concept with which every investor can build an individual world portfolio tailored to their personal needs and preferences.
In this blog post, you can find out what the most important construction principles are and how to put them into practice.
(1) The four scientific pioneers behind the world portfolio concept
The central scientific principles from which the world portfolio concept is derived were developed by four American economists who all won the Nobel Prize in Economics (at different times) for their pioneering contributions to financial economics or macroeconomics:
- James Tobin (1918 – 2002). He formulated the “Tobin Separation Theorem”. It states that “optimal portfolios” are made up of only two basic components, a “risk-free” (low-risk) part and a risky portfolio part.
- Harry Markowitz (1927 – 2023). He showed for the first time how to construct an “optimal portfolio” of individual assets that represents the mathematically best possible combination of return and risk.
- William Sharpe (born 1934). His research has led to the distinction between “systematic” and “unsystematic” (or “idiosyncratic”) risks. Idiosyncratic risks can be “diversified away” and are therefore not statistically compensated for by the capital market through excess returns. Only systematic risks cannot be diversified away. As an investor, you can therefore statistically only expect the market to compensate you for systematic risks, which is why you should only have these risks in your portfolio.
- Eugene Fama (born 1939): The market efficiency hypothesis, according to which it is probably impossible in the stock market and certain other financial markets to systematically (not just randomly) outperform a passive benchmark in terms of cost and risk using publicly available information alone, due to their “information efficiency”. Fama was also a pioneer of factor investing (see section 9 below).
To make use of the findings of these four economic superstars and other top researchers as a private investor, you don’t need to understand the mathematically and statistically complex elements of what is known as Modern Portfolio Theory in detail. It is sufficient to know the central conceptual conclusions. This blog post aims to help with this.
(2) Dr. Gerd Kommer’s world portfolio – a brief definition
The world portfolio is the translation of the above and other research findings into a “complete”, “fully integrated” investment concept that
- ordinary private investors (as opposed to institutional investors)
- in Do-it-yourself mode
- with investment products available on the retail market
- at low cost
- with any small or large investment amount
- with little time expenditure
- for the purposes of long-term asset accumulation or the preservation of existing assets
are able to practice.
Even this draft summary makes it clear that the world portfolio concept is realistic and can be implemented in the long term (for a lifetime) for normal private investor households. As a global portfolio investor, you don’t have to be a stock market freak who spends ten or more hours a week on financial topics.
The portfolio should be integrated and adapted holistically, as recommended by science, to the income and asset situation of a private investor household – throughout an adult life with all its changes and also during existential life crises.
Kommer first named and described the world portfolio concept in 2001 in his book “Weltweit investieren mit Fonds”. One year later, in 2002, the first edition of his subsequent bestseller “Souverän investieren mit Indexfonds und ETFs” was published. The book initially sat on the shelves of bookshops like bricks. However, with the onset of the Great Financial Crisis in mid-2007, sales of the book began to rise. in 2016, the book won the German financial book prize awarded by Deutsche Börse AG and Citibank.
To date, around 300,000 copies of Souverän Investieren and simplified, shorter versions of it have been sold. In the editions of the book, which have been revised approximately every four years, as well as in the monthly blog that has existed since 2017, Kommer has repeatedly updated the world portfolio concept in an evolutionary manner and has addressed special aspects. A completely revised seventh edition of the book Investing confidently with index funds and ETFs will be published in January 2025.
In Souverän Investieren, the world portfolio concept is derived from science and described. Here we have summarized a brief world portfolio definition with the most important key aspects:
The term world portfolio stands for an investor portfolio that consists of two main conceptual components: A “high-risk” part of the portfolio, which is responsible for generating returns in the overall portfolio (the “return driver”), and a “low-risk” part of the portfolio, which primarily serves as an anchor of stability and security in the overall portfolio. Both parts of the portfolio are highly liquid. Other core aspects and characteristics are: (a) maximum global diversification and elimination of all single asset and default risks, (b) disciplined, consistent buy and hold, supplemented by rules-based rebalancing to reduce return losses and opportunity costs (lost profits) from timing as well as the effective tax burden, (c) the reduction of costs through the use of low-cost index funds and ETFs, and (d) the reduction of counterparty risks from e.g. banks, other financial service providers and financial product manufacturers to a level that cannot be further reduced.
The definition components (a) and (b) implicitly contain the important avoidance of active, forecast-based investing, as this produces unattractive risk-return profiles from a scientific perspective. Active investing in capital market investments is done by means of security selection or market timing or a mixture of both. Active investing in its infinite number of individual forms “is what everyone does”. It has a global market share of over 95%.
In the rest of this blog post, we look at the requirements for a real world portfolio according to Gerd Kommer and use specific products and solutions to show what such a portfolio could look like in its simplest form.
(3) The division into a high-risk and a low-risk part of the portfolio (“level 1 asset allocation”)
From a bird’s eye view, the world portfolio can be divided into a high-risk portfolio component, risk asset (RA) and a risk-free portfolio component, risk-free asset (RFA). The RA is the return driver responsible for generating the portfolio return, while the RFA serves as a “safety or stability anchor” in the portfolio. We call this dichotomy Level 1 asset allocation.
As far as the allocation between RA and RFA is concerned, all combinations from 100% RA/0% RFA (“100/0 portfolio”) to 0% RA/100% RFA (“0/100 portfolio”) are conceivable. A 100/0 world portfolio has the highest expected return, but will also fluctuate widely (be volatile) over time. A 0/100 portfolio, on the other hand, has the lowest expected return, but also hardly fluctuates over time. In practice, the action is somewhere in between for the vast majority of private investors, as few will prefer the fringe allocations.
In a simple version of the world portfolio, the RA consists of one or more index funds/ETFs that track the global stock market. The asset class (asset class) stocks is the asset class with the highest long-term return, higher than the corresponding average returns of real estate, bonds, commodities, precious metals or collectibles or financial products derived from or related to these asset classes, such as interest-bearing bank deposits, capital-forming life insurance policies or hedge funds. (Private equity investments have statistically similar returns to stocks, but are riskier and more illiquid – see here and here)
The RFA is not expected to contribute a significant long-term average return after costs, taxes and inflation, as such an expectation would be at the expense of the core function of stability anchor. Significant positive real returns after costs and taxes could only be achieved in the past and will only be achieved in the future in the long term by bearing risk.
The RFA consists of highly liquid government and corporate bonds with (a) a short time to maturity (and therefore little interest rate change risk), (b) low credit risk (and therefore default risk that can hardly be reduced) and (c) no exchange rate risk. (If you would like to read more about interest rate change risk, please refer to our blog posts “Bonds and interest rate changes – a case study” and “The interest rate change risk of bonds“)
For RFA investment volumes of up to EUR 100,000, you could also use an overnight money deposit with a bank, as this amount per bank-customer combination is within the statutory (state) deposit guarantee in the EU.
(4) Forecast freedom and maximum global diversification
An essential advantage of the world portfolio concept is that – unlike active investment strategies or actively managed financial products – it does not require any forecasts, i.e. no forecasts of securities prices, economic variables (e.g. interest rates, inflation, economic growth) or other developments in society, politics and the economy that influence the stock market.
We know from science that making economically exploitable forecasts on the capital market is largely unsuccessful. The damage from following the majority of incorrect forecasts outweighs the benefit from following the minority of correct forecasts.
Investment forecasts are ultimately bets on one or more of the following investment aspects:
- Single stocks (stock picking);
- individual countries, sectors or topics;
- individual fund managers or “gurus”;
- individual time periods (market timing);
- the development of the economy or interest rates; or
- the monetary policy of central banks
If you would like to find out more about why such bets generally don’t work out, you can read our blog post “Ten reasons why active investing doesn’t work“.
In short: These kinds of bets represent bad, because they are avoidable (“diversifiable away”) risks that are not worth taking due to the lack of expected compensation (in the form of an expected return). Conversely, it is therefore advisable to avoid forecasts of any kind, especially when it comes to important matters such as retirement provision. This can be achieved by relying on the entire market economy, i.e. maximum global diversification and buy and hold. This can be easily implemented with regard to stocks by purchasing a suitable index fund/ETF that tracks the global stock market.
(5) Buy and hold & Rebalancing
Buy and hold (B&H) is just as important a basic principle in the world portfolio concept as freedom from forecasts and global diversification. B&H (a) reduces workload and costs (especially by minimizing the costs of buying and selling), (b) lowers the effective tax burden in a tax system like the German one (see here) and (c) eliminates the potential damage to returns from bad, emotion-driven timing decisions. This is particularly likely to be the case for private investors, as behavioral finance research (behavioral economics) and empirical financial market research have shown many times.
In the world portfolio concept, B&H is linked to rebalancing. Rebalancing is the rule-based restoration of the desired percentage weightings (target weightings) of all positions in a portfolio over time after they have “moved away” from the previously deliberately selected target structure due to market effects. This “path development” will inevitably occur sooner or later in practice and does not contradict the buy and hold concept. The reason for this is that without rebalancing, the composition and thus the risk-return profile of a portfolio would change over time due to market fluctuations and move away from the actual investor preferences. Rebalancing is also a special form of anti-cyclical (“contrarian”) investing based on the sell-high/buy-low principle. If you would like to find out more about rebalancing, please refer to our blog post “Rebalancing: advantages, methods, principles“.
(6) Reduction of costs
All other things being equal, costs reduce the net return on an investment, i.e. the return that really matters. Costs act like a negative compound interest effect.
Here is an example calculation: With a starting capital of EUR 5,000, an average annual return of 10% and costs of 0.5% per year, the final asset value after 30 years is a good EUR 76,000. However, if the annual costs had been 1.0%, the final asset value would only be around EUR 66,000 – EUR 10,000 or almost 15% less.
As costs are one of the few influencing factors in investing over which you have a high degree of certainty and control, it is particularly worthwhile to actually exercise this control.
Moreover, the old general rule “higher quality also costs more” does not apply when investing. Rather the opposite is the case: Some of the most expensive investments, such as hedge funds, closed-end funds or capital-forming life insurance policies, are also the ones with the lowest returns.
(7) Elimination of process-related and financial product-related counterparty risks
A sometimes overlooked part of the world portfolio concept is the consistent avoidance of process and financial product-related counterparty risk inherent in most forms of active investing. What do we mean by that?
Many financial products, e.g. endowment life insurance, private pension insurance, certificates, many private equity investments, hedge fund investments, investments in closed-end funds, investments on some crypto exchanges and investments in P-to-P loans, are linked to (typically overlooked) counterparty risks. In other words, if the counterparty in question gets into financial difficulties or even goes bankrupt, the investor’s money may be partially or completely lost. Incidentally, this also applies to bank deposits above the state deposit guarantee of 100,000 euros per bank-customer combination.
In principle, there are no such counterparty risks with the world portfolio concept because (a) index funds/ETFs – unlike the financial products mentioned above – are legally so-called special assets and (b) the bank only acts as a custodian in the case of a bank deposit, not as a debtor as in the case of a bank deposit.
(8) A simple graphical representation of the world portfolio concept
The following overview shows a simple graphic illustration of the general basic structure of a global portfolio.
(9) Optional: The world portfolio in the factor investing variant
As an optional add-on worth considering, so-called factor premiums can be taken into account when constructing a global portfolio. Factor premiums are characteristics of securities that can be used to increase the expected return (i.e. the statistical average return) of a portfolio compared to the total market. Over the last 100 years or so, factor investing (using two or more factor premiums) would have generated a return that was significantly more than one percentage point per year above that of the “normal” stock market (the total market) – with similar risk in terms of volatility (fluctuations in return).
The best-known factor premiums are
- the small-size premium: Small companies in terms of market capitalization tend to yield better returns than large ones.
- the value premium: Companies with favorable valuations (e.g. measured by key figures such as the P/E ratio) tend to yield better returns than highly valued (“expensive”) companies.
- the quality premium: Companies with low debt and high profitability (e.g. operating profit margin) are, on average, more profitable in the long term than companies at the other end of the spectrum (low quality companies).
- the momentum premium: Stocks that have had significantly above-average returns in the last twelve months will tend to continue to do so for another three to six months before falling back to average or below.
- the low investment premium (also known as the low asset growth premium): Companies that have had below-average (“thrifty”) total balance sheet growth in the recent past tend to generate higher stock returns than companies with high total balance sheet growth (“profligate” companies).
The longer the observation period or investment period, the clearer the factor premiums become. By way of illustration: With a super-short observation period of one day, the stock market statistically has a return above zero in 53% of all cases (days). If the observation period is extended to ten years, the key figure “proportion of returns above zero” increases to 93%. A similar law applies to excess returns from factor premiums.
You can read more about factor investing in this blog post.
(10) Possible world portfolio solutions
(a) For investors who want to invest on their own (in Do-it-yourself mode):
In the simplest case, a world portfolio can be implemented with one ETF for the risky part of the portfolio and one for the low-risk part. For an investor who wants a 100/0 Level 1 asset allocation or wants to use overnight money within the government deposit guarantee for the RFT, even an ETF alone will work.
In its simplest form, such a portfolio could look as follows (as at July 2023):
- RA – Stocks global: L&G Gerd Kommer Multifactor Equity UCITS ETF (WKN: WELT0A) or SPDR MSCI ACWI IMI UCITS ETF (WKN: A1JJTD)
- RFT – short-term bonds with high credit ratings and no exchange rate risk: L&G Corporate Bond ex-Banks Higher Ratings 0-2Y ETF (WKN: A40E7Q) and/or Xtrackers II Germany Government Bond 0-1 UCITS ETF 1C WKN: DBX0T8). As mentioned above, the low-risk part of the portfolio can alternatively be mapped via an overnight money account at a bank, provided the corresponding investment amount is within the state deposit guarantee of EUR 100,000 per customer-bank combination.
| Important disclaimer: These are expressly not investment recommendations, but merely an illustration of how the world portfolio concept could be implemented in a simple way. The RFA is not “risk-free” in the literal sense of the word. Please inform yourself independently and read all product documents before making an investment decision. |
(b) For investors who do not want to invest on their own but would like to be supported:
– From an initial minimum investment amount of EUR 5,000 with internet-based advice: The Robo Advisor from Gerd Kommer Capital (GKC). Here you are taken by the hand: You do not have to select individual ETFs, the robo proposes the level 1 asset allocation based on the customer’s details and determines the level 2 asset allocation (the product implementation of the level 1 asset allocation) for you, takes care of opening the custody account, buying ETFs (and selling them if necessary), rebalancing and reporting, including the annual preparation of a tax certificate. Savings plans and withdrawal plans as well as subsequent investments and withdrawals can be triggered at the touch of a button. There is an app for smartphones. Customer support is available as a point of contact. GKC invests according to the world portfolio concept.
– From a minimum investment amount of one million euros: Gerd Kommer Invest (“GKI”): Holistic initial and ongoing financial advice and asset management for high net worth individuals. Asset protection concepts and succession planning via foundation solutions are also included in the scope of services.
Conclusion
The world portfolio is a fully integrated investment approach derived from science that enables private investors to make capital market-based, long-term investments for the purposes of asset accumulation and wealth preservation.
The world portfolio concept can be implemented independently or through delegated investing. Gerd Kommer’s guidebooks, his monthly blog, which has been running since 2017, his YouTube channel and other publications by him, which are linked to in Gerd Kommer’s monthly newsletter, help with this.
For those who cannot or do not yet want to implement the world portfolio concept on their own, we have outlined some alternatives in this blog post.
Further information on the world portfolio concept
Guide books:
Gerd Kommer, Gerd (2018): “Souverän investieren mit Indexfonds und ETFs. Wie Privatanleger das Spiel gegen die Finanzbranche gewinnen”; Campus Verlag, 5th edition, 2018 (first edition 2002); 415 pages – a completely revised new edition will be published in January 2024.
Gerd Kommer, Gerd (2022): “Der leichte Einstieg in die Welt der ETFs: Unkompliziert vorsorgen ein Starterbuch für Finanzanfänger”; Finanzbuchverlag; 1st edition 2022, 176 pages – a very simple beginner’s book (requires no prior knowledge of the stock market)
Gerd Kommer, Gerd (2022): “Souverän investieren für Einsteiger: Wie Sie mit ETFs ein Vermögen bilden”; Campus Verlag, 2nd Edition, 2018; 272 pages – a beginner’s book for readers who already have a basic knowledge of the stock market
Gerd Kommer, Gerd (2021). “Kaufen oder Mieten – Wie Sie für sich die richtige Entscheidung treffen”; Campus Verlag, 3rd edition, 2021; 280 pages
blog posts:
Gerd Kommer, Gerd; Schweizer, Jonas (2021): “Rebalancing: advantages, methods, principles”; blog post; December 2021; link: https://backup2.gerd-kommer.de/rebalancing/
Gerd Kommer, Gerd; Schweizer, Jonas (2021): “Save taxes through buy and hold”; blog post; October 2021; link: https://backup2.gerd-kommer.de/steuern-sparen-buy-and-hold/
Gerd Kommer, Gerd; Weis, Alexander (2019): “The interest rate risk of bonds”; blog post; December 2019; link: https://backup2.gerd-kommer.de/zinsaenderungsrisiko/
Gerd Kommer, Gerd; Weis, Alexander (2019): “Factor investing – the basics”; blog post; May 2019; link: https://backup2.gerd-kommer.de/factor-investing-die-basics/
Gerd Kommer, Gerd; Weis, Alexander (2020): “The Pains of Factor Investing”; blog post; May 2020; link: https://www.gerd-kommer-invest.de/pains-of-factor-investing/
Gerd Kommer, Gerd; Weis, Alexander (2020): “Ten reasons why active investing works badly”; blog post; February 2020; link: https://backup2.gerd-kommer.de/warum-aktives-investieren-schlecht-funktioniert/
Weis, Alexander; Gschossmann, Selina (2022): “Passive investing – the basics”; blog post; September 2022; link: https://backup2.gerd-kommer.de/passiv-investieren-die-basics/
Weis, Alexander; Kanzler, Daniel (2022): “Bonds and interest rate changes – a case study”; blog post; June 2022; link: https://backup2.gerd-kommer.de/anleihen-und-zinsaenderungen/
Weis, Alexander; Gerd Kommer, Gerd (2019): “Timing your market entry – does it work?”; blog post; March 2019; link: https://backup2.gerd-kommer.de/timing-des-markteinstiegs/
Gerd Kommer, Gerd; Kanzler, Daniel (2022): “Leveraging equity investments with credit – does it work?”; Nov. 2022; link: https://backup2.gerd-kommer.de/leverage-effekt/