Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors

Abstract:     
In sharp contrast to the recommendations of Modern Portfolio Theory (MPT), a vast majority of investors are not well diversified. This neglect of diversification is seen across all wealth segments, including the affluent. This paper attempts to provide a solution to this "diversification paradox," by expanding the Markowitz Framework of diversifying market risk to also include the concepts of Personal Risk and Aspirational Goals.

The Wealth Allocation Framework enables individual investors to construct appropriate portfolios using all their assets, such as their home, mortgage, market investments and human capital. The investor may choose to accept a slightly lower "average rate of return" in exchange for downside protection and upside potential. The resulting portfolios are designed to meet individual investors' needs and preferences, as well as to protect individuals from Personal, Market and Aspirational risk factors.

The Wealth Allocation Framework attempts to bring together MPT with aspects of Behavioral Finance through a single pragmatic Framework. A major conclusion of this work is that, for the individual investor, Risk Allocation should precede Asset Allocation.

Number of Pages in PDF File: 28

Keywords: Wealth Allocation Framework, Diversification, Risk Allocation, Aspirational Risk, Markowitz, Market Risk, Personal Risk, Asset Allocation, Wealth, Risk, Investing

JEL Classification: G1, G11, G12, D10, D31, D81, D91

Accepted Paper Series