Do You Deliver Income Effectiveness in Addition to Portfolio Efficiency?

Investment management uses the idea of efficient portfolios based on the statistics and probabilities of risky assets as the variable. Let’s call this “x”.

Retirement management adds the idea of effective portfolios based on the statistics and probabilities of the clients’ exposures to several types of risks, including risky assets. Let’s call this “f(x)”.

Consider that a portfolio is deemed efficient, under Modern Portfolio Theory (MPT), when diversification achieves an optimal risk/return trade-off in the elimination of un-systematic risk, leaving the client with the retention of the systematic risk that cannot be diversified away. These calculations are based on the statistics and probabilities of the stocks and bonds, not on the statistics and probabilities of the client’s risk exposures to them. This is focused on “x”.

If you map the risk exposures of retirement clients across the Household Balance Sheet View℠, you will observe that their relevant risk exposures go beyond the volatilities and correlations of risky financial assets to include behavioral and chance risks (as identified and taught in the Retirement Management Analyst® (RMA®) Curriculum). These are idiosyncratic, un-systematic risks that cannot be reduced through diversification among risky assets. This is focused on “f(x)”.

Thus, ranking the validity of retirement portfolios must consider other dimensions besides MPT efficiency.

RIIA®’s “View Across the Silos”℠ makes our framework the most complete and objective mapping of the retirement territory. In addition, one of the more intuitive mappings, the Household Balance Sheet℠, makes practitioners comfortable working in the Consumption space without having to calculate utility functions.

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