Investors have a tendency to focus on the characteristics of their portfolios almost to the exclusion of other factors that will lead to success or failure for the larger objective that the portfolio is intended to serve. By taking into account the characteristics of the assets and liabilities that exist outside of their investment portfolios, they could build portfolios that are a better match for the true problem they should be solving. Because the liabilities and assets outside of the portfolios do not generally have quantitatively well-estimated characteristics the way that traditional investment assets do, this type of analysis necessarily involves a certain amount of judgment rather than simpler historical return analysis. But this effort seems well worth the attempt, because most apparently rigorous attempts to build “optimal” investment portfolios are solving the wrong problem for most investors.
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