Defining investor objectives in terms of mean and standard deviation: A) makes it more difficult for the investment advisor to select a suitable benchmark index. B) may make it easier for the investor to make a connection between the investment policy and the investor’s own goals. C) will typically simplify the process for the investment advisor.

c

I go with C as well.

C

C

ill try Bf or diversity

c

Well… I go for B too.

I’ll go with C, although B sounds reasonable. However, I’m sticking with the rule that investors typically don’t like things represented as mean and/or standard deviations as they see it as “confusing”.

^ Exactly. The point here is that mean and standard deviation are easy for an advisor to use, but to the investor they don’t make a whole lot of sense. Advisor: “If we go with this portfolio, your mean annual return will be 9% with a standard deviation of 14%. I know this because I averaged the numbers from the fund prospectuses and was lazy and didn’t feel like doing any extra work.” Investor: “…” Investor: “So does this mean I will be able to put my kids through school and retire by X age or not?” Often it can be more effective for the advisor to frame the issues in terms of likelyhood of meeting certain goals and likelyhood of falling short of those goals. This is not as easy for the advisor to determine but is much easier and more effective to the average investor.

B isn’t right. That is how it is done in tradional (evil) finance. In behavioral finance they say you should define the risk return in terms of the probability of shortfall relative to your goals. You set up efficient frontier using the those variables instead of absolute terms of mean and SD. Edit: Didn’t see Dwight’s post.

You are right. In fact, I didn’t read the word ‘Investor’ at B correctly, I interpreted it as the advisor who translates the investor’s wishes to these risk/return characteristics. Then still I don’t like C very much but it’s least wrong.