The Impact of Uncertain Commitments

Abstract

Integrated wealth management implies individualized risk control. The discretionary wealth approach is used to calculate a better risk-aversion relationship for trade-offs between expected return and risk based on the investor’s extended balance sheet, inclusive of present values of future financial commitments. We can improve it by taking into account the uncertainty with which the particular investor’s discretionary wealth is estimated. Present values of retirement spending, taxes on unrealized capital gains and estates, and potential bequests and charitable contributions may be more usefully regarded as probability distributions than as point estimates. An example shows how uncertain future lifespan results in a more conservative portfolio, reducing in this case the optimal stock allocation from 80% to 73% to 64% as we make successive improvements in analysis.

TOPICS: Wealth management, retirement, portfolio construction