Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors

The Journal of Wealth Managment, Vol. 7, No. 4, pp 8-34, Spring 2005

28 Pages Posted: 21 Aug 2006

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.

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

Suggested Citation

Chhabra, Ashvin B., Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors. The Journal of Wealth Managment, Vol. 7, No. 4, pp 8-34, Spring 2005. Available at SSRN: https://ssrn.com/abstract=925138

Ashvin B. Chhabra (Contact Author)

Institute for Advanced Study ( email )

Einstein Drive
Princeton, NJ 08540
United States
609.734.8163 (Phone)

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