Revisiting the Asset Allocation Challenge Through a Behavioral Finance Lens

Abstract

The author looks into the potential application of Statman's behavioral finance portfolio to help investors and their advisers formulate an appropriate strategic asset allocation. He starts by reviewing a few major behavioral finance findings and moves on to propose a set of four potential fundamental investment objectives, which investors must prioritize and among which they must allocate 100% of their wealth. He then designs sub-portfolios specifically geared to deliver on each of these objectives. The overall strategic asset allocation is then derived from aggregating these sub-portfolios into a single whole. The author concludes with observations on the unintended benefits of such an approach and an admonition that it does not in any way invalidates the fundamental principles underpinning the strategic asset allocation process.