PUBLISHER: Journal of Wealth Management
DATE: Summer 2020
PDF: Not available due to copyright restrictions
Whereas “A Goals-Based Theory of Utility” is a theoretical piece, this is geared toward implementing the theory.
In this paper, I address how to elicit the relative value of goals as well as how to deal with the recursivity of goals-based optimization. I provide R code as an example of the optimization procedure. Finally, I discuss the firm and industry implications of the approach.
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.
Wealth management, behavioral finance, portfolio theory, portfolio construction