Goals-Based Portfolio Theory

Some Final Thoughts

As I hope you will now agree, goals‐based investing really is different. It is much, much more than a marketing buzzword. Dare I say it has become its own branch of portfolio theory.

The central point of goals‐based investing is to align the math with what it is investors are actually trying to achieve. Modern portfolio theory, when invented, did not have the benefits of modern computing power. Thus, simplifying assumptions had to be made to make the framework manageable. Markowitz himself discussed these necessary shortcuts once, saying that as long as portfolio returns did not fall “too far” into the extremes “too often,” then the management of portfolio mean and variance was an appropriate proxy.¹ However, with modern computing power, we might as well discard the simplifying assumptions (some of which are so absurd as to be laughable) and build the model again.

It is simply not possible for investors, of any stripe, to leverage a portfolio without limit or cost. Most investors are also bound in their ability to sell securities short, by both account type and regulation. These two assumptions, central to modern portfolio theory, have been widely critiqued, of course, but continue to persist. My estimation is that they persist because there has been no realistic alternative. Goals‐based portfolio theory may well be that alternative—dispensing with many of the absurd assumptions and focusing on how real investors can achieve real goals using real markets. ...