“An industrial revolution is about to take place in money management.”

That proclamation comes from Lionel Martellini, a finance professor and director of EDHEC-Risk Institute, who helped organize a conference to discuss how fintech can provide goals-based portfolio management—an issue gaining global attention. The conference, held in April 2017 at Princeton University, attracted a score of academics and 140 investment professionals from around the world. Below is my first-hand synopsis of the goals-based investing revolution discussed at the conference as I have interpreted its application for advisors.

The personal is more complex than the institutional

The complexity of personal portfolios is obvious to those of you who are private wealth advisors. After all, you deal with multiple goals, family complexity, uncertain salaries, health, longevity and the ambiguity that often surrounds the establishment of priorities. This idea was presented by John Mulvey, a professor of operations research and financial engineering at Princeton University. Because they manage large assets, institutional managers sometimes consider themselves more sophisticated. But, if an advisor claims to bring institutional techniques to the retail investor, the client’s response should be “good start, but not good enough.”

Further, there are two types of investors: the very wealthy and the rest of us.

The very wealthy have the money to address all essential and aspirational goals. For them, investing is about growing wealth, not meeting goals. Because they can fund their expenses, they can afford to be patient, long-term investors. As with trusts and foundations, diversification is their primary risk management tool, and they can apply the tenets of modern portfolio theory (MPT)—an approach that considers only assets (as per Fabozzi, Gupta and Markowitz in their 2002 article for The Journal of Investing, “The legacy of modern portfolio theory”). Investing and rebalancing to a fixed asset mix may be sufficient because they have the time and resources to make back losses. Wealth accumulation being the focus, maximizing risk-adjusted returns is a reasonable objective.

However, only a small proportion of investors are truly this wealthy. For most investors, essential goals, like saving for retirement, or aspirational ones, like owning a vacation home, are possible only by combining current savings, future savings, and investment growth and income. These unfunded goals are actually contingent liabilities, says Woo Chang Kim, associate professor and head of the KAIST Center for Wealth Management Technologies at the Korea Advanced Institute of Science and Technology. This calls for asset-liability matching (ALM), rather than MPT. Investing for the long term can be challenging for these investors, who must prioritize goals if funds are limited.

The problem and its source

Many of you probably manage portfolios as if your clients were from the very wealthy group, even though a goals-based approach would be more appropriate. But it’s not your fault; it’s the way the industry developed, finds Kim.

Individual investing is derived from the trust department approach for estates and foundations, established more than a century ago. The objectives are to maximize total long-term returns, generate enough income to meet annual spending needs, and preserve capital while providing consistent results. Asset allocation for these mandates has varied over the decades, starting with 100% fixed income for most of the 20th century to support 4% to 5% income annually.

Today, endowments like those of Yale and Harvard are more than 90% equities, with variable spending formulae to smooth results. Diversification can include an array of asset classes, including private equity, infrastructure, timberland, private debt and hedge funds. This approach is suitable for perhaps 1% of individual investors—the very wealthy.

How to apply goals-based investing

Some argue that goals-based portfolios contain the same holdings and are just displayed differently. This can be true if no real effort is made to match assets to liabilities. If fixed asset-mix strategies continue to be applied, returns are unchanged. However, showing that portfolios address essential and aspirational goals can improve investor understanding and confidence even if the investment technique (i.e., MPT) is deficient.

In a $1-million portfolio example (see Table 1), five goals are shown, categorized as either essential or aspirational. The number-one priority is to have two years of eldercare costs available for a dependent mother ($120,000). The number-two priority is college tuition ($130,000). A potential solution consists of creating two portfolios—one safety and one growth.

Let’s assume the stock market falls sharply, and the client comes in for a review. Sample conversations follow.


“The market is down 10% for the quarter, but your portfolio was down only 6%. And, over three years, your compounded annual growth rate is still 5.3% versus the benchmark 4.7%.”

Advisor’s implied conclusion:

Good performance.

Client’s inferred conclusion:

Will I be able to afford the things that are most important to me?


“Two years of eldercare expenses for your mother are covered (so she won’t have to live with you!), and Sarah’s tuition to Harvard Business School is covered.”

Advisor’s implied conclusion:

The safety portfolio fully covers essential goals for eldercare and college.

Client’s inferred conclusion:

Whew, I’m covered!


To make goals-based investing work, all academic presenters at the conference relied on multi-stage stochastic programming (an optimization approach that uses a series of decision trees to test combinantions of variables—some known, some unknown, and/or some that can be estimated). Stay tuned to learn about a more practical and effective investment technique in a future article.

Table 1: Goals-based portfolio allocationIllustrated are constant-risk portfolios (over 5, 24 and 18 years) that describe both an investment time horizon and a downside-risk floor—important components in asset-liability matching. For the safety portfolio, “5 years” means that in five years the worst return will be return of capital (ROC) plus inflation, with 95% likelihood, and that there is a 99% chance that the worst 12-month period will be better than -5%, thus providing a return floor. For the growth portfolio, “24 years” means that in 24 years the worst return will be ROC plus inflation, with 95% likelihood, and that there is a 99% chance that the worst 12-month period will be better than -24%.

Mark Yamada is President of PÜR Investing Inc., a software development firm. Disclosure: PÜR Investing Inc. provides risk-based model portfolios to Horizons ETFs.

Originally published in Advisor's Edge Report

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