Issues Related to Goals-Based Asset Allocation

Suppose you're working with a single, young client, Lim Ya, who is just beginning to save for retirement. This is Lim's only goal, so in this case, traditional asset allocation would work just fine to achieve her single purpose. But say you discover that Lim is also very new to investing and fears losing money as she begins to save. What asset allocation approach might you use to try to address this behavioral issue?

Exactly! One way to adjust Lim's asset allocation is to use the goals-based asset allocation approach because you can set a specific goal over the first several years to make Lim more comfortable with investing. You would essentially take less risk over the initial period, with the goal of gaining Lim's trust so she sticks with investing. This is just one example of how goals-based asset allocation can be more than just an approach for an individual with multiple goals, time horizons, and urgency levels.

That's not it. The liability-relative approach addresses a core liability funding need, which Lim doesn't have.

No. That's not a good starting point because it won't address Lim's fear of investing.

In fact, it's probably a smart idea to run a goals-based process just to ensure that clients with only a single goal aren't combining multiple objectives into a single purpose. For example, Lim may assume that her retirement goal is inclusive of her desire to buy a home within five years, since she intends to live in the home throughout her retirement. By using the goals-based approach for clients with multiple goals, time horizons, and urgency levels, you can assess how clients perceive their goals in relation to their earned capital. What's another way to describe this client understanding?

Not quite. For most clients, capital comes from working.

That's not it. Investing returns is a key part of the process.

Right! There's a trade-off between goals, human capital, and investing that clients must face, and a goals-based asset allocation strategy puts these relationships into an easier framework. For example, in order to achieve her retirement goal and buy her home, Lim may have to work to a certain age (human capital) or take more risk in her portfolio.

Goals-based asset allocation helps clarify these issues, and it also provides a broad approach for many types of clients. But unsurprisingly, the bigger the client, the bigger the issues typically are. Naturally, a larger asset base makes the investment problem more complex, the investment opportunities more diverse, and the client's personalized service expectations even higher. So you'll need to be careful when it comes to maintaining a fiduciary and regulatory relationship with all clients. When it comes to larger clients, what's the regulatory risk?

That's not it. Managing individual modules isn't a regulatory issue if it's done consistently.

No, actually. Larger clients naturally have a larger opportunity set because they can meet higher minimum investment requirements.

Exactly! Regulatory bodies require that all clients be treated equally, so a special service reserved only for larger clients isn't a good idea. So even though larger clients can require unique policy structures, and even day-to-day portfolio management at times, you want to ensure that all clients are treated equally and fairly. What's a smart approach to ensuring that clients are treated fairly?

Not quite. The process should have some standard applications, so it's not completely customized.

No, actually. A rigid process won't allow you to address client-specific goals.

That's right! The firm should have a systematic framework that allows for the identification of client goals and uniform capital market expectations and strategies. Then, the process can shift into more client-specific insights, like individual asset capital needs and the client's individual goals, before a more standardized approach combines the client's insights with firm-wide portfolio modules. This way, each client receives unique attention while getting the firm's full resources.

To sum it up: [[summary]]

Goals based

Liability relative

Mean–variance optimization

The trade-off of risk and return

The trade-off of human capital and risk

The trade-off between goals, human capital, and investing.

Managing individual modules

Unique investment opportunities

Special service based on asset size

Customized framework

Rigid firm-wide processes

Systematic framework with specific client insights

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