William Reichenstein

Calculating a family’s asset mix

Abstract Two conclusions are reached about how a family should calculate its asset mix. First, if the assets will be used to finance retirement needs, the asset mix should be based on after-tax values, because goods and services are purchased with after-tax dollars. This novel conclusion rejects current practice. The second conclusion concerns which assets and liabilities should be included in the portfolio. If the purpose of the calculation is to consider a family’s retirement needs, the asset mix should include the promises of defined-benefit pension plans and Social Security, and the family’s mortgage should be treated as a short bond position. Also, if the family is willing to downsize or borrow against the residence, part of its value should be included in the portfolio.

Asset Allocation and Asset Location Decisions Revisited

The author applies a mean-variance optimization approach to examine the asset allocation and location decisions made by individuals. The experiment is limited to two assets—stocks and bonds—which are alternatively held through pension or through taxable accounts. They aim to determine the best combination of asset allocation and asset location, effectively asking the question: “to the degree possible should stocks or bonds be located in the tax-sheltered pension account?” The author considers three types of investors: a trader (who realizes all capital gains within a year), an active investor (who realizes all gains each year but pays preferential tax rates), and a passive investor. He finds that, for traders, there is always more than one optimal portfolio, and there is no optimal asset location: Identical portfolio risk and portfolio return can be obtained with different combinations of asset allocation and asset location. For active and passive investors, the optimal portfolio locates, to the degree possible, stocks in taxable accounts. The analysis offers several investment implications. For example, when someone makes the asset-location decision first, the conditional optimal asset mix calls for a relatively large exposure to the asset held in taxable accounts; thus the optimal stock weight is larger when stocks are held in taxable accounts than when they are held in pensions.

Risk Perceptions of Intitutional Investors

0 ver the past 30 years, mathematical modeling has proven to be a powerful methodology in financial research. Much of it has focused on the use of objective measures of market-wide risk,’ especially ex post beta. Risk, however, is such an elusive concept that it cannot be handled easily with mathematical precision. The disenchantment with beta by theoreticians and practitioners alike (Roll [19] and Wallace [22]), has led to a shift to a study of risk perception at the individual level in some of the recent literature. Our study takes this ”nontraditional” approach, in that it begins with risk ratings provided by portfolio managers and security analysts and then analyzes which of the publicly available measures of risk (some based entirely on past data and others based at least in part on subjective input) best “explain” the perceived risk. The publicly available measures of risk that we analyze are the dispersion of analysts’ forecasts, plus the following measures of risk published by Value Line: beta, safety, timeliness, price stability, earnings predictability, and growth persistence. We then regress a measure of expected return on the risk measures to examine which measure of risk the market seems to be pricing. Studying risk at a market-wide level is not the only, and perhaps not even the best, method of study-

After-Tax Asset Allocation

Several studies have found fundamental flaws in the traditional approach to managing individual investors’ portfolios, including a failure to distinguish between

Calculating the Asset Allocation

1 of pretax funds in a 401(k) and

Savings Vehicles and the Taxation of Individual Investors

1 of after-tax funds in either a taxable account or Roth IRA. This study recommends that an individual’s asset values be converted to after-tax values and the asset allocation be based on the after-tax values. In general, within the target asset allocation, individuals should hold bonds and other assets subject to ordinary income tax rates in retirement accounts and hold stocks, especially passively managed stocks, in taxable accounts. Several studies have concluded that we have been mismanaging individual investors’ asset allocations in two ways. In this article, I describe one of these errors—namely, the failure to calculate an individual’s asset allocation on an after-tax basis. The traditional approach to calculating asset allocation fails to distinguish between

Perspectives from the Literature of Private Wealth Management

1 of pretax funds in a 401(k) and

The Extended Portfolio in Private Wealth Management

1 of after-tax funds in a taxable account or Roth IRA. Yet, if withdrawn in retirement today by someone in the 33 percent tax bracket, the

Two key concepts for wealth management and beyond

1 in the 401(k) will buy

After-Tax Wealth and Returns Across Savings Vehicles

0.67 of goods and services whereas the