Midwestern Financial Group I Fiduciary Advisors I Wealth Management


Three Primary Determinants For Optimal Asset Allocation

This is the first of a four-part series discussing the three primary determinants required in order to arrive at allocating assets and to provide planning outcomes and opportunities. Admittedly for some, this write-up may seem overly simplistic, but for others, it is our hope that the simplicity serves a greater understanding concerning how practitioners and MFG in particular, arrive at allocating your hard-earned monies.  

We work diligently to slow the process down to first get to know our clients, to listen to your financial concerns and needs, and to provide an opportunity to introduce our firm, guiding principles, and members. After all, our hope is that our relationships with clients will span decades and generations.  

Financial planning is inherently personal and requires a great deal of trust by both parties. We work with our clients to understand three primary drivers that ultimately determine the success of their financial future.  

  1. Financial Resources – today and tomorrow 

  2. Risk Tolerance – capacity and willingness 

  3. Financial Goals – determines time horizon 

Financial Resources 

At the very core of financial resources are your personal assets, liabilities, income, expenditures, and savings rate(s). It is critically important to capture a sense of what your current financial affairs look like in order to determine not only the amount of risk required to generate an adequate return to meet your financial goals – be it near- or long-term – but also assist us in understanding sensitive inputs to arrive at financial outcomes given your current financial position. It also assists us in determining level of financial sophistication.  

The following list includes various data points we capture, but is far from a comprehensive list: 

  • Net worth statement (assets and liabilities) 

  • Income from various sources  

  • Expenditures  

  • Taxation  

  • Debt schedules 

  • Human capital – earnings growth and risk  

  • Insurance policies 

Risk Tolerance 

We recognize that a person's true measure for risk is likely best measured during the most challenging of market environments. However, your tolerance for risk is a key input computing return expectations by way of the overall allocation of your portfolio that, in part, is anchored to your risk tolerance. The less risk one is willing to take, the lower the return expectation. 

At MFG we invest an incredible amount of time understanding our client’s tolerance for risk – both their willingness and capacity to take risk. This is accomplished through discussions and qualitative and quantitative assessments. We do this for a couple reasons: 

  1. It is not unreasonable to believe there may be conflict between one’s willingness to take risk and their capacity to take risk. 

  2. Should the conflict go unacknowledged, the net result may be impaired realized investment returns due to inability to stay the course during a drawdown or marginalized long-term returns due to an allocation that is lite on risky assets 

We firmly believe the greatest value we provide to our clients is by way of managing behaviors. At the center of this is risk assessment. The study and practice of behavioral finance is core to what we do for our clients at MFG.  

Financial Goals 

The last and certainly not the least of the inputs are your financial goals. Proper asset allocation should be fastened to your financial goals as it is those that often determine the timing of withdrawals. We often say internally that our first priority is to preserve what you have earned and then enhance it; meaning that when it comes to funding a liability, such as education or retirement, we want to be certain near-term withdrawals are not subject to unnecessary volatility. Long-term assets, or assets needed to fund your goal in the intermediate or long-term, can then assume greater risk and volatility to allow for growth.  

Simply put, your financial goals determine your time horizon and timing of funding that particular liability. For much of what we have discussed today, there are general guidelines. As it relates to financial goals and retirement, it is common for some to believe it is prudent your allocation follows the glidepath of your age and therefore reduces equity (risk) exposure as you age. As a generalization, this may be true for the average investor. However, we caution its applicability as it relates to optimizing financial outcomes.  We firmly believe the allocation of your assets should replicate your financial resources, tolerance for risk, and financial goals.

Your overall asset allocation should be representative of your time horizon, risk tolerance and financial resources. 

In closing, significant investment and time is required to determine your appropriate allocation of assets. Absent of this, there’s a chance you're not optimizing your financial outcomes. MFG remains consistent in our fiduciary capacity – offering objective financial advice on the premise of optimizing your financial outcomes, not the interests of corporate profits.  

Midwestern Financial