Setting an Asset Allocation Strategy by Balancing Personal and Market Risks

Abstract

The authors start with the proposition that there is a need to expand beyond the traditional framework for evaluating asset allocation strategy and introduce a new concept they call “personal risk.” Their approach assumes that an investor's preferred asset allocation is influenced by his or her tolerance for fluctuations in the market value of the portfolio, and the probability of achieving his or her financial goals. The latter—the aforementioned personal risk—is measured by the ratio of anticipated net cash outflows to the portfolio's current market value. This article defines the concept of personal risk and introduces a framework to create a strategic asset allocation that balances personal and market risks.