PFP2620. From MVO to NWO: Two Approaches To Generating Retirement Income

An individual’s total portfolio includes more than just financial assets, such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). It also includes assets such as human capital and real estate. Unfortunately, a total portfolio also includes a type of soft liability, the net present value of future consumption, for example, a retirement income. For better or worse, this is reality.

The individual’s economic balance sheet can be reflected with the following equation:
Total portfolio = Financial assets + real estate + human capital – liabilities

Rather than optimizing financial assets in isolation — the common Mean-Variance Optimization (MVO) practice—all investors (or their planners and advisors) should consider embracing a total portfolio optimization approach that includes all of the elements of the economic balance sheet. This type of holistic balance sheet optimization is referred to as Net Worth Optimization (NWO) because net worth equals the total portfolio:
Net worth = Financial assets + real estate + human capital – liabilities

This session is ideal for all investors and advisors who are considering a move from MVO to NWO.

Learning Objectives:

• Interpret the key elements of an individual’s economic balance sheet, including human capital and a liability.
• Calculate the net present value of an individual's human capital.
• Contrast how different careers might influence how to model human capital.
• Assess how to extend the traditional Markowitz mean-variance optimization process, also known as Modern Portfolio Theory, to a more holistic economic balance sheet optimization process.