Calculating the Asset Allocation

Abstract

The fourth and last in a series that integrates investments and taxes, this article challenges two features of the traditional approach to calculating an individual or family's asset allocation. The author argues that the traditional approach includes only financial assets in the portfolio and it weighs them according to their market value. It ignores other assets, such as a company pension, for instance. Thus, it makes no adjustment for the fact that the deductible pension contains before-tax dollars and the savings account contains after-tax dollars. The author recommend calculating the asset allocation based on after-tax values and also shows that the decision of what to include in the family portfolio can dramatically affect the measured asset allocation. Presenting the logic of converting market values to after-tax values, he then discusses, for assets in each savings vehicle, how to convert market values to after-tax values, and presents a family's hypothetical portfolio, asking how one should measure its asset allocation. He shows that the measurement of the family's asset allocation can vary dramatically depending upon what is included in the portfolio and whether one uses market values or after-tax values.