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Goal-based investing based on multi-stage robust portfolio optimization

Abstract

While portfolio optimization is generally based on the return and risk of a portfolio, goal-based investing primarily focuses on achieving financial goals of individuals, which has become a popular approach in personalized financial planning. While many long-term financial planning models use scenarios for representing uncertainty in future market dynamics, it is subject to the curse of dimensionality. In this study, we propose a goal-based investing model for personalized lifetime financial planning based on robust portfolio optimization, which incorporates multiple goals that occur in different periods with various priorities. Empirical results illustrate how the size of uncertainty sets and risk constraints can be customized for finding the optimal investment and show efficiency in solving a portfolio problem with many stages compared to scenario-based approaches.

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Notes

  1. See Aoun et al. (2012) and Aouni et al. (2014) for surveys on other stochastic models and fuzzy approaches for goal programming.

  2. See Bertsimas and Pachamanova (2008) and Ben-Tal et al. (2000) for further details.

  3. Historical returns of the 10 industries are retrieved from the online data library of Kenneth R. French, which also contain a description on the categorization and construction of the industries.

  4. A simplified investment setting is presented but the model can be applied to lifetime financial planning.

  5. Multi-stage stochastic programming is used for formulating the scenario-tree based model. The objective is to maximize expected spending on predefined goals and the problem is solved incrementally starting with the highest priority goals. A detailed explanation is included in Kim et al. (2020).

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Acknowledgements

This research was supported by Basic Science Research Program through the National Research Foundation of Korea (NRF) funded by the Ministry of Science, ICT & Future Planning (NRF-2018R1C1B6004271) and funding provided to Fabozzi by EDHEC Business School.

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Correspondence to Frank J. Fabozzi.

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Kim, J.H., Lee, Y., Kim, W.C. et al. Goal-based investing based on multi-stage robust portfolio optimization. Ann Oper Res 313, 1141–1158 (2022). https://doi.org/10.1007/s10479-021-04473-7

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  • DOI: https://doi.org/10.1007/s10479-021-04473-7

Keywords

  • Portfolio optimization
  • Robust optimization
  • Goal-based investing
  • Personalized financial planning