Practical analysis for investment professionals
18 November 2016

Has Goals-Based Investing Ruined Modern Portfolio Theory (MPT)?



It’s time to develop a more practical risk-management measure.


Let me explain why.

The Exclusion of Illiquid Assets 







Difficulties in Forecasting, Risk Profiling, and Definitions







The Rise of Behavioral Finance and Goals-Based Investing



I was behaving pretty much like my clients.








Image credit: Getty Images/MHJ

About the Author(s)
Hansi Mehrotra, CFA

Hansi Mehrotra, CFA, is the founder of The Money Hans, a personal finance education blog aimed at retail investors. Mehrotra has over 20 years of financial services industry experience, primarily in online delivery of investment research and consulting for the wealth management industry. She set up the wealth management business for Mercer’s Investment Consulting business across Asia Pacific. She also led a number of projects in India including design of the investment options for the National Pension Scheme. She holds a Bachelor of Arts degree from Delhi University, and a Graduate Diploma of Applied Finance and Investments. Mehrotra has been named TopVoice and PowerProfile on LinkedIn.

22 thoughts on “Has Goals-Based Investing Ruined Modern Portfolio Theory (MPT)?”

  1. Agree. But what are your proposed alternatives?

    1. Goals-based investing, like that proposed in the Beyond Markowitz paper, can be overlaid with qualitative/quantitative risk management.

  2. MPT is over simplification of a complex problem. Using variance as a risk metric might make it easy to develop models but it has two major limitations, in my view: (i) Quantitatively speaking it does not reflect the concave utility (ii) Even bigger issue is that it assumes that rational investors would take decision purely based on mean-variance framework. The most investors don’t even understand mean-variance framework, obviously the theory is bound to fail.

    1. *Thus, when most investors do not even understand mean-variance framework, obviously the theory wouldn’t hold good in practice.

  3. Richard says:

    Bless you for saying this!!! I have looked everywhere for an advisor who would include our house as part of our portfolio and who could calculate what it might mean to add a small rental property or two. So there is a niche where your talents are desperately needed…

  4. Thank you Richard. I realised the house problem 20 years ago but didn’t have an alternative, not realising my 3 mental buckets were the solution. Yes I now use my experience to do investor education. Experimenting with a simple to explain concept – would love your feedback. Check out

  5. Nathan Erickson says:

    While goals based investing may be more appealing to the retail public, how does one go about building the portfolios for each of the goals? Are they single asset classes? Fixed rate bonds? MPT provides a process for determining an appropriate asset allocation, given the tools one has to work with. Markowitz never said it was an exact science, nor that it would lead to the perfect portfolio. Assumptions matter, as do constraints, and asset classes. The true value of MPT is a disciplined process as opposed to guessing which asset classes to use in what amount. There is a reason MPT has survived for 60+ years and continues to be used by the largest asset managers in the world.

    Retail clients can benefit from an understanding of the probabilities of outcomes provided by an MPT analysis. Where risk tolerance questionnaires can fail, ranges of outcomes and historical performance of an asset allocation can add tremendous value to a client determining an appropriate allocation.

    1. Agreed, the utility of MPT for retail investors is for risk diversification rather than efficient frontiers. But wealth managers try to force-fit it with arbitrary assumptions.

      All I am saying is we need to vaguely right than precisely wrong.

      1. Nathan Erickson says:

        All assumptions in investing are arbitrary, whether you use MPT or not. Goals based investing can help address behavioral tendencies, but you still have to build the portfolios for each bucket. For example, you mention your long-term superannuation would be 100% equities. Would it be globally diversified or all domestic? Large cap? Small cap? Determining that would require arbitrary assumptions. One could certainly decide to weight by market cap, however if a more efficient solution was available by optimizing based on risk, return, and correlation, wouldn’t one want to do that?

        1. That’s the point….as a retail investor I don’t care about ‘efficiency’ which is more about balancing volatility with return. If you are investing for the long term,volatility isn’t as relevant. I invested in Asian equities with an absolute oriented manager because I thought that gives me a good chance of a good return without having to check my portfolio every day or month or quarter. I may not have the most efficient portfolio but the point is I don’t care. And this is when I enjoy finance. Now imagine a person who is not into finance. What do they really care about?

          1. Nathan Erickson says:

            I misunderstood then, I thought your article was regarding advising clients, not from the perspective of a retail investor. Regardless, I think retail investors do care about efficiency, they just aren’t aware of the opportunity. I’ve yet to explain to a client the benefit of maximizing return for a given level of risk and have them say that’s not appealing to them.
            What people care about differs from person to person. Your example of investing in an absolute oriented Asian equities manager reflects that you are much more concerned about losing money than you are about the level of return. Someone who buys a levered equity ETF cares more about return. MPT doesn’t require checking a portfolio with any level of frequency. It’s just a process that provides guidance in decision making.
            If our clients could embrace that when investing for the long term, volatility isn’t as relevant, we would all be better off. But again, as you alluded to, all investors have to deal with behavioral tendencies, which means volatility is always relevant.

  6. Catherine Shenoy says:

    MPT fails because we don’t have an appropriate risk measure. In the real world there is no risk/reward trade-off over a wide rank of scenarios. The variance/covariance matrix is not stable. Asking people to come up with their risk tolerance without a sound way to measure risk is senseless. I think Mr. Mehrotra points this out well.

    I agree that understanding variability in returns is useful for investors, but the profession has a lot of work to do in coming up with new ways to define risk. MPT is fatally flawed.

    1. Thanks Catherine. Yes, we need to come up with a more intuitive and subjective way to help retail investors spread their risks. Perhaps something like Bridgwater’s All Weather Fund. I am exploring a factor-based approach that can be explained easily. Happy to hear other suggestions.

      ps – It’s a Ms, not Mr. I know my name sounds Swiss German but it’s Sanskrit for swan.

    2. Nathan Erickson says:

      As Howard Marks puts it, for most investors the only real measure of risk is the permanent loss of capital. That occurs for two reasons: investing in something that can become worthless, or an emotional response at an inopportune time, preventing mean reversion to occur for a given allocation. MPT is not fatally flawed, but mischaracterized. It is not designed to prevent or eliminate losses! Even the comment that the variance/covariance matrix is unstable may be a reference to 2008, when correlations theoretically went to 1 (for a brief period of time). However an investor who owned stocks AND bonds lost less money than an investor who only owned stocks, proving that MPT works. An investor’s appropriate risk measure is substantially dependent upon their time horizon. And even then, not necessarily their investing time horizon, but their emotional time horizon. An investor who has the ability to monitor their portfolio less frequently will find they can tolerate a lot more risk.

      The fatal flaw is in characterizing MPT as a volatility elimination tool. Earning return requires a willingness to bear risk. MPT provides a defined methodology to determine what level of risk / return tradeoff an investor can tolerate.

  7. Sanjiv Das says:

    See my paper with Markowitz, where we show that you can map goals based investing to MPT.

    1. Very nice article, Hansi! Kudos for the fluid language and comprehensive coverage…

      I use a combination for my clients. Risk profile based asset allocation, and within the asset class using factor-investing to optimize security selection and more importantly to avoid behavioral follies…

      As a risk measure, clients feel more comfortable with Max Drawdown or Downside volatility, which I believe are more suitable to retail investore.

      Nehal Joshipura, PhD

  8. Isn’t this ‘both /and’ as in quantum physics? Ashvin Chhabra’s wealth allocation framework and MPT are like ‘being a particle and a wave’ – as confounding as that is for an advisor. Hansi, you’ve nailed it, and so did Ashvin Chhabra; you both advocate a more complete approach. MPT continues to offer an excellent metric for measuring the advisor, e.g., Wharton professor Marston’s alpha star uses the capital market line to illustrate to a client how they’re doing on a risk adjusted basis. Clients intuitively grasp this, just as they love the logic of Chhabra’s ‘buckets.’

  9. Eunice Amaglo says:

    Thanks very for this post, Hansi–it’s an enlightening and a refreshing read. All the fancy underpinnings of MPT don’t mean much to the retail investor. I believe, also, that it’s of use to advisors ensure some kind of balance between risk and return even while their portfolio constructions are goal-driven.

    1. Hansi Mehrotra says:

      Thanks for your feedback, Eunice.

      Yes, goals-based investing also require for a risk/return framework. I am trying to tackle it by grouping goals into various risk/return buckets. So there are essentials, for which a low risk/return is fine. The long term goals can be invested in diversified equities. The aspirational goals have to be concentrated bets, hence high risk/return. The trick is to figure if and how to determine asset allocation.

  10. Max says:


    I tried accessing the article mentioned in the blog, but it does not work anymore.

    Can someone help?
    Thank you!

  11. Sean Slotterback says:

    But even in the Chhabra article, MPT is really doing the heavy lifting. The third mental bucket is arguably tacked-on and not relevant to every investor and the first two buckets can be considered jointly in a MPT framework with constraints on downside.

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