Allocation of Wealth Both Within and Across Goals: A Practitioner’s Guide

Abstract

Although the goals-based investment literature has grown, there remain two unsolved problems. First, there is no cohesive theory for the allocation of wealth across goals. If, for example, a client wants to retire in 30 years, send a child to university in 8 years, and buy a vacation home in 4, how she should divvy her wealth across those goals has been an open question. Restating the same problem: The vesting of shorter-dated goals carries a loss of achievement probability for longer-dated ones. How much probability loss is acceptable? Second, mean-variance portfolios yield lower probabilities of goal achievement than goals-based portfolios. I demonstrate use of the goals-based method. Parker (2020) introduced a cohesive goals-based allocation model that solves these problems. The approach, however, carries some practical challenges that are addressed in this discussion. Finally, I discuss some possible implications of the approach on the structure of firms, the regulatory environment, and the industry as a whole.

TOPICS: Wealth management, performance measurement

Key Findings

• • Recent breakthroughs in goals-based portfolio theory now direct how wealth should be rationally divvied across goals, as well as how wealth should be allocated to investments within goals. This discussion is a “how to” for practitioners operating in a goals-based setting.

• • Goals-based wealth allocation results in higher probabilities of goal achievement relative to mean-variance optimization. Though mean-variance portfolio allocation can be adapted to a goals-based context, it yields lower probabilities of goal achievement.

• • There are numerous implications for the industry under a goals-based paradigm. High-variance, low-return investments may yet play a role in portfolios, the line between investment manager and advisor is now fuzzier, and the regulatory ossification of mean-variance portfolio theory creates hurdles for goals-based practitioners.