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A high-tech approach promises maximum returns, but common sense is really what you need to protect your portfolio.

Question: I’m 65 and retired. A financial planner has told me that by using “modern portfolio theory” he can create a retirement portfolio for me that doesn’t require any bonds. What do you think of this idea? - C.K., Ohio

Answer: I think this is one of those cases where you have to weigh what might be possible in theory against what is the more prudent course in the real world.

I have immense respect for modern portfolio theory - or MPT as it’s affectionately known in investment circles - which, among other things, deals with how to maximize your return for whatever level of risk you’re willing to accept.

One of the more interesting and useful insights of MPT is that by mixing and matching different types of securities, you can actually create a portfolio that, paradoxical though it may seem, is less volatile than its individual parts.

The key is choosing investments that don’t all move in synch with each other, so that while one is being hammered, another might be soaring to gains. The result is that the zigging and zagging of the various investments smooths out the ups and downs of your portfolio, while allowing it to generate attractive gains.

So I suppose it’s possible that an adviser using an “optimizer,” or a software package that incorporates modern portfolio theory techniques, could create a retirement portfolio designed to be as secure as the rock of Gibraltar but that holds no bonds or other fixed-income investments.

You should know, however, that achieving this Nirvana in computerized simulations and getting the results in the three-dimensional world are two different things.

The reason is that when an adviser creates a maximum-gain-for-minimum-pain portfolio using MPT, they must make assumptions about three crucial variables: the expected rate of return of the various assets, the correlation of those assets (that is, how much or how little they move in unison) and the volatility of the assets (how much they jump up and down). And if those assumptions don’t pan out, the portfolio can go kerflooey.

Now, you could say you run the same risk with any portfolio since you’re always making assumptions about how different types of assets will perform. But when an adviser creates a more extreme portfolio - and I think it’s fair to say that a portfolio that has absolutely no bonds is definitely “out there” when it comes to a retiree’s holdings - there’s a greater chance that the actual results may vary dramatically from forecasted results.

It’s almost as if you designed a racecar specifically to exploit the straight-aways of the Indianapolis Motor Speedway, but on race day the competition was moved to a different type of course - say, a winding road with tight curves or a small oval track. There’s no way your car would travel at anything close to the speed you were expecting.

And that’s the crux of the issue. In the investment world, you’re never quite sure what scenario you’ll face. So as a practical matter, you’re generally you’re better off with a more moderate portfolio that can perform decently in a wide variety of conditions than an extreme one that may thrive in a few situations but crash and burn in many others.

Please understand that I’m not advocating that you or any other retiree hunker down in a portfolio that’s all bonds - or, for that matter, even nearly all bonds. Indeed, although the exact percentages can vary depending on individual circumstances, I think people your age should typically have 50% to 55% of their money in a broadly diversified blend of stocks. Even retirees in their ‘80s should generally keep 20% to 30% of their portfolio in equities.

Nor am I necessarily against diversifying into other assets, such as real estate or commodities (although I think you have to be careful not to overdo it, especially these days when “alternative” investments are over hyped).

But when I hear someone saying they’re going to construct a portfolio that completely excludes a major asset class, particularly one that has features that are a good fit for most retirees (namely, income and low volatility), I’m naturally suspicious.

So if I were you, I’d be very wary about entrusting my retirement savings to this person. And if you’re thinking about going ahead with this portfolio, then at the very least, you ought to consider running it by another pro. (To find someone who might take a look at it on a flat-fee or hourly basis, click here.)

Bottom line: I’m all for keeping an open mind to innovation. But when it comes to retirement savings that took you an entire career to build, you don’t want to take unnecessary chances, especially when you don’t have to.

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