Chhabra’s 3 Buckets Strategy: Personal, Market, and Aspirational Goals for Success
By Paul White, CAIA, Ph.D.
“Everything should be made as simple as possible but not simpler.” – attributed to Albert Einstein
How does one break out the wealth allocation? Is it foreign versus domestic? Is it Large Cap versus Small Cap? Is it Liquid versus Illiquid? Or is it Traditional versus Alternative?
Ashvin Chhabra is a notable quote, who devised a wealth allocation framework. A trained physicist (just like Einstein), Chhabra did not write down the equation modelling all assets across all market regimes. Chhabra’s paradigm for investing includes 3 simple ideas – Personal, Market, and Aspirational1.
The following is a crude and perhaps inadequate of the Wealth Allocation framework laid out by Dr. Ashvin Chhabra. The reader is encouraged to find one of the many sources on the internet with better aesthetics and primary source material.
Unconsciously or consciously…
This is an unfounded assertion, but probably most advisors (and their clients) do this. What do I need to live today, what do I need to live tomorrow, and how much outright gambling can I do? These are all questions that get answered in the Wealth Allocation framework. They are “natural” categories, or buckets, that we tend to fill without thinking and oftentimes without formalism. The explicit callout of these buckets lends itself to organization and structure upon which to fall back. Whether this is front and center to the client approach or is somewhere in the back office, these buckets endure.
Personal: This is the bucket where the client pays the bills. It is also called “lifestyle” because this is what it takes to maintain one’s standard of living. What does one need cash on hand today to meet one’s obligations. Lump all the monthly bills into this bucket. Think home mortgage, credit card bills, etc. In accounting speak, it is matching current assets with current liabilities. The largest portfolio risk here (since we are dealing with cash) is inflation.
Market: None of us can work forever, so this is that nest egg that we want to grow over time with a reasonable rate of return for a reasonable amount of risk. Investments here are in equities, fixed income, alternatives, and structured products. Growing that lump sum consistently and safely is the place where the advisor works his/her magic. The benchmark is something that is risk-adjusted to the overall market. We want to participate in the market and let it work for us.
Aspirational: After we pay todays and tomorrow’s bills, what else is there? This is that lottery ticket that will propel us into a standard of living greater than what we already have. Think of all the investment ideas that one hears at cocktail parties. High risk and high return are the hallmarks of this bucket. The investment is sized appropriately such that total loss will not affect the rest of the client’s well-planned future. A lottery ticket a month is something along those lines. If it works out, fantastic! If it doesn’t work out, that’s O.K. For investments like hedge funds, private credit, private equity, and venture capital, think absolute return vehicles marked by accreditation or limited partnerships.
From this point the advisor has his/her work cut out. Risk tolerance evolves over time and there is every expectation that the relative sizes of the buckets will change. The contents will also change as an investor reaches his/her horizon from maybe a portfolio with all equity and no fixed income 100/0 to a portfolio with zero equity and all fixed income 0/100. Market crashes will test the client’s risk tolerance as well as the work that the advisor put into accurately sampling it. Quantitative techniques will be useful here.
Whatever the approach that follows, Ashvin Chhabra’s 3 Bucket approach to Wealth Allocation will be a great place to start. If you’re already doing it without thinking, then this framework can help organize one’s thoughts. If this is newer to you, then maybe it should go into your permanent toolkit.