The computer half solves quickly for the return on assets that, when coupled with other sources of income, will support the desired level of spending. In the meantime the human advisor deals with investor psychology and emotion, offering alternatives to spending and suggesting other sources of income. For example, if the investor could spend less or bring home more wages the required return would decrease.
The required return is revisited frequently, navigating the investor toward his or her goals through time. In that way, actual investment performance is incorporated as are life events and other changes.
Financial Engineering Complemented by Intuition
Asset allocation is financially engineered to achieve the necessary return. The Separation Principle employs the Nobel-prize winning structure developed by Dr. William F. Sharpe – the Capital Asset Pricing Model (CAPM). Asset allocation is a blend of just two assets: a broadly diversified World Basket of risky assets (stocks, bonds, real estate, commodities, etc) and a low risk Safe Asset. Here’s a sample World Basket.
Applications
This future is now. Asset allocations are being determined as described above, using underlying funds of all types – ETFs, mutual funds, etc. Target risk and target return funds are examples, as is my patented Safe Landing Glide Path® for target date funds, which combines CAPM with liability-driven investing (LDI). Similarly, the “pockets of money” solution for the very wealthy is a limiting case of this approach, because the required return is near zero.
Robo advisors may co-exist alongside their human advisor competitors for a long time to come, but the evolution will be toward a combination of the two, providing benefits of both at a reasonable cost. Better living through science and intelligence.