Asset Allocation and Modern Portfolio Theory are the backbone of current and prudent investment philosophy and strategies. The problem is these strategies typically will not account for your non-stock & bond investments and risks...

That is, you may have a relatively conservative asset allocation of your invested assets, but this is not taking into account any of your real estate, private equity investments, pre-IPO stock options, privately held businesses, and so forth. So what, you might ask. Well, if you have other investments held separately from your invested equities, you won’t be accounting for the risk/reward of that asset and its impact to your overall financial strategy. Or you won’t account for the doubling down on a particular asset class, such as owning REITs (Real Estate Investment Trusts) with your liquid investments along with owning investment real estate, giving you much more real estate exposure than you may otherwise think prudent. Or another example, someone who has significant stock options associated with their employment comprising 50% of their overall investments may want to consider having their non-stock option assets invested significantly more conservative to off-set the concentrated risk of the single holding stock options.

Now if you aren’t familiar with the terms, asset allocation is an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investors risk tolerance, goals and investment time frame. And Modern portfolio Theory (MPT) is a theory of investment which attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets. Not to gloss over – there’s much more to investment philosophy, theory and strategy. My point being these strategies typically are not accounting for someone’s overall financial situation inclusive of other assets and liabilities.

At a recent annual review with one of our clients, our Chief Investment Officer, Mark Duval, and I came across this very issue of not accounting for the “true” or overall asset allocation. Our clients had been invested in our Moderate Growth portfolio, a slightly aggressive asset allocation and, if considered purely on its own for the investment objectives of our clients, is very well suited for their situation, objectives, risk profile, etc. These clients have owned their own privately held business for many years and have been very successful in the running and growing of that company. Over the past year, they had expanded significantly, purchasing 3 additional like-companies in new markets. If they can execute on their plans with the new businesses (as they have demonstrated they can with their first company), they will be very successful financially and will be able to take care of their financial ambition. But the expansion of their business does present some additional risk, including risk of liquidity among other things. So now the Moderate Growth portfolio simply may be too aggressive. And in fact we discussed this with them and decided to modify their investment strategy so that their overall “true” asset allocation was indeed appropriate for their situation and goals.

Jeff Smith has been helping families in the Marin community for more than 17 years. As a trusted financial advisor and mortgage advisor, Jeff helps his clients make better financial decisions to improve the outcomes of the financial choices in life.