posted 07/21/10 | Wealth Management
Drew McLaughlin, Vice President & Client Advisor
Enterprise Trust Company
More than five decades after Harry Markowitz outlined the foundations for Modern Portfolio Theory, many individual investors are still not diversified. In fact, a large majority of America’s most wealthy investors would not have become so had they followed a diversified approach to wealth management. So that being said, where do we go from here?
Family investors should consider a broader approach to wealth management that includes the concepts of personal risk and inspirational goals. A framework that enables them to achieve their goals based on their entire balance sheet, not just their investment portfolio. One attempt to explain such an approach can be found in ”The Journal of Wealth Management”, vol. 7, no. 4, Spring 2005, Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors by Ashvin B. Chhabra. A major conclusion of this article is that, for the individual investor, risk allocation should precede asset allocation.
One should consider multiple factors when creating a diversified portfolio such as the market risk and return of each asset class and the correlations between these classes. However, a majority of the population that adopted Modern Portfolio Theory failed to realize that it is a defensive strategy, designed primarily for wealth preservation. Wealth enhancement is a secondary or tertiary result of diversification. In order to build and compound wealth, a portfolio must have a heavy concentration and better than average execution. An example would be a business owner concentrating his or her wealth in the business to compound the value over time.
Asset allocation, as described by Modern Portfolio Theory will lower the risk of a portfolio with proper understanding and implementation. Risk can be minimized but the family advisor and the family decision makers need to understand the trade off between risk reduction and wealth creation. The bottom line in this great debate is that the level of risk will determine the level of reward.
If you would like to find our more about Enterprise Trust Company’s approach to comprehensive wealth management, please contact Drew McLaughlin in our Clayton Office at 314.512.7121 or