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Abstract
Suppose a wealth manager has the discretion to allocate the timing of client account inflows or outflows over a calendar year. Inflows include client, employer, or government contributions and outflows include management fees and client withdrawals. If the client has prospect theory preferences and anchors gains and losses against the previous account balance, then the manager’s optimal timing of account inflows and outflows can increase client satisfaction. The optimal strategies allocate inflows to offset small portfolio losses and assess outflows to offset large portfolio gains. The author compares the optimal strategies to strategies that allocate inflows or outflows equally every quarter or month. The client is indifferent between inflows of 1.4% to 1.6% allocated equally and 1% allocated optimally. The client is indifferent between outflows of 0.58% to 0.70% assessed equally and 1% assessed optimally. Managers who structure account inflows and outflows to target prospect theory preferences and the anchoring effect can increase individual investor savings.
TOPICS: Wealth management, portfolio theory, portfolio construction, performance measurement
Key Findings
▪ Some managers have discretion to allocate client account inflows and outflows over time. It is possible to model and solve for the manager’s optimal allocation strategies, assuming the client has prospect theory preferences and anchors expectations about gains and losses to the previous account balance.
▪ I compare the optimal strategies to strategies that allocate inflows or outflows equally over time. Optimal wealth management strategies can substantially improve client satisfaction, which financially benefits both the client and manager.
▪ The value of optimal wealth management is robust to expectations about market volatility. The manager’s decisions improve outcomes for the client and manager because prospect theory investors care much more about losses than gains.
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US and Overseas: +1 646-931-9045
UK: 0207 139 1600