Behaviorally Modified Asset Allocation (BMAA)

Behaviorally modified asset allocation definition

Behaviorally modified asset allocation helps investors to deal with adverse conditions. In these situations, many investors tend to abandon their investment strategy. Such an outcome can be very detrimental to performance, because people tend to abandon their strategy at a low point, right before a recovery begins.

By determining a strategy in advance that the client can more easily adhere to it during adverse periods. In particular, BMAA considers whether it is better to moderate or adapt to the client’s biases, in order to construct a portfolio the client can stick with:

• Moderating a bias attempts to reduce or eradicate the bias from the individual’s decision making
• Adapting to a bias involves acknowledging the bias is there and adjusting for it rather than trying to minimize or eliminate it

BMAA starts by determining an optimal strategic asset allocation consistent with traditional finance. Next, it determines the relative wealth of the client and the emotional versus cognitive nature of the client’s biases to adjust that allocation.

In particular:

• people with a lot of wealth versus lifestyle implies a low standard of living risk (SLR). In such cases, clients can afford to deviate from the optimal portfolio
• biases that are mainly cognitive are easier to moderate because they are based on faulty reasoning
• biases that are mainly emotional are harder to moderate. In that case, they may have to be adapted to, resulting in a less efficient portfolio
• the amount of deviation from the optimal portfolio to accept should be determined. If the allocation deviates too much, it should be adjusted back