Investment portfolio construction comes in many different forms depending on who the designer is, and more importantly, what the investor expects from the portfolio.
We believe an investment strategy must be built on sound research tailored to the goals of the investor, and utilizing Capital Market Assumptions (CMAs) is a valuable tool within this process.
What Are CMAs?
CMAs are the expected returns, standard deviations (i.e., volatility), and correlation estimates that represent the long-term risk/reward forecast among the spectrum of asset classes¹. CMAs are widely used by investment professionals to estimate what could occur over the next 10 to 20 years.
CMAs as a Tool, Not a Crystal Ball
While CMAs provide valuable insight, they should never be seen as an infallible or singular source of truth when constructing an investment portfolio. We believe CMAs are a building block of portfolio construction, and they must be adapted and supplemented as circumstances evolve.
How Are CMAs Developed?
CMAs are derived from historical data, economic models, and expert projections. Investors and wealth planners use CMAs to construct diversified portfolios, guide asset allocation decisions, and set performance benchmarks. We believe CMAs should act as a guardrail, providing direction in uncertain markets.
However, relying exclusively on CMAs can lead to suboptimal outcomes. Michael Sebastian, in his article The Accuracy and Use of Capital Market Assumptions (2023), highlights how CMAs often fail to predict actual market returns, emphasizing the need for adaptability of investment strategies.
As with any prediction, CMAs are inherently speculative, and while they can aid in decision-making, they should not be treated as the ultimate authority on future market behavior.
The Limitations of CMAs
One of the most significant limitations of CMAs is their reliance on historical data. Most investors have heard or read the commonplace investment disclosure, “past performance does not guarantee future results,” which goes against the thesis of CMAs assuming future market behavior will mirror past trends.
As Sebastian discusses, the assumption that market conditions will repeat themselves is risky, particularly when considering unpredictable events like the Great Financial Crisis of 2008 or the COVID-19 pandemic in 2020, which caused market disruptions outside historical patterns.
The Danger of Overlooking Market Extremes
Additionally, CMAs often focus on average outcomes, which can obscure extreme market events. By relying on historical averages, CMAs can downplay the risks associated with market shocks or crises, which can significantly affect returns.
Investors who base their strategies solely on these assumptions might be ill-prepared for such rare but impactful events. Dimensional Fund Advisors provided a study in 2024 detailing how actual market returns have frequently deviated from the projections made by CMAs years earlier, even though they were created by subject matter experts.
Assumptions About Asset Class Correlations
Another issue with CMAs is their assumption that asset classes will continue to behave predictably relative to each other. For instance, many traditional models assume a negative correlation between stocks and bonds—when one rises, the other falls.
However, shifts in interest rates, inflation, or investor behavior can alter this relationship. The point of portfolio construction is to build diversified asset allocations tailored to the needs of the investor, and relying solely on CMAs without adjusting for current market conditions and behavioral tendencies of the client can be detrimental to the long-term outcome.
The Value of CMAs in Portfolio Construction
Despite their limitations, CMAs serve a useful purpose for constructing and maintaining optimal portfolios. We believe CMAs should function as a starting point for investment decisions, but they must be updated regularly in response to changing market conditions, economic trends, and geopolitical events. As financial markets evolve, so should the assumptions that guide investment strategies.
Enhancing CMAs with Stress Testing and Scenario Analysis
Scenario analysis and stress testing are additional tools to assess portfolio performance under different market conditions. These methods allow investors to better understand potential risks and outcomes, complementing CMAs by providing a more comprehensive view of market dynamics.
A Balanced Approach to Portfolio Strategy
Capital Market Assumptions are a valuable tool to guide investment decisions, but they should not be treated as the sole determinant in portfolio construction. We believe there are two primary factors that drive portfolio performance – asset allocation and persistent investing – and CMAs act as a guardrail to support the decisions by offering direction in an uncertain environment.
By supplementing CMAs with ongoing analysis, stress testing, and a flexible approach to investment strategy, investors can build more resilient portfolios capable of weathering market uncertainties.
To learn more, contact one of our trusted advisors.

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