Monday, May 21, 2007

Risk Allocation In A Wealth Portfolio

Since my entire retirement income will initially be derived from my retirement savings, I have been learning more about how to manage investment risk. I was already aware portfolio risk management for stocks and asset allocation. My financial advisor shared another approach which is summarized in the Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors by Ashvin B. Chhabra in THE JOURNAL OF WEALTH MANAGEMENT, vol. 7, no. 4, Spring 2005, which discusses the use of Risk Allocation as a strategy to manage wealth. (The full article can be downloaded at the link.) A major conclusion of this article is that, for the individual investor, risk allocation should precede asset allocation.

While the author agrees with Modern Portfolio Theory (MPT) on equity allocation, he proposes that MPT is necessary but not sufficient part of Wealth Allocation. Wealth allocation should also include a low risk/low return bucket (e.g. home, cash) and a high risk/high return bucket (e.g. investment real estate.) A diversified stock portfolio would only be part of the mid risk/mid return bucket.

Here's how Chhabra allocates a wealth portfolio by risk buckets:

Allocation By Risk Bucket

Personal Risk

Market Risk

Aspirational Risk

PurposeMaintain basic standard of livingMaintain lifestyleEnhance lifestyle
Asset Allocation
  • Cash

  • Home

  • Home Mortgage

  • CDs and Bonds

  • Insurance

  • Human Capital (Income from job)

  • Equities

  • Fixed income

  • Cash - For opportunistic investments

  • Alternative investments - hedge funds

  • Investment real estate

  • Small business

  • Concentrated stock position or stock options

  • Recommended Percentage




    My Percentage




    This article and analysis was eye opening for me. My percentages are skewed towards the aspirational risk, primarily due to my retirement account being invested in company stock. (For reference, company stock is the only option available for my employer contributions.) This analysis also helps me understand why I have been more comfortable with low risk investments in my personal accounts - i.e. because I am currently over invested in the aspirational risk category. So the 47% percent of investments that I directly control are split 77% cash equivalents and home, and 23% in the stock market.

    Also, as I think about a retirement investment strategy, I will need to consciously decrease my concentration in company stock and increase my exposure to the overall stock market.

    For more on Strategies and Plans Ideas , check back every Monday for a new segment.

    Photo Credit:, Scott M. Liddell

    This is not financial or investment advice. Please consult a professional advisor.

    Copyright © 2007 Achievement Catalyst, LLC

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