Not Your Father’s Mean-Variance Optimization

This article introduces a practical method to maximize expected after-tax wealth and to fine-tune risk management utilizing linear programming instead of traditional Markowitz mean-variance optimization (MVO). Our simpler approach simultaneously optimizes asset allocation and asset location while considering capital gain impacts at the tax lot level. It is designed to be applied to portfolios individually. The approach's primary benefits include: explicit tax consideration across multiple types of accounts and tax-lot analysis within the optimization model, the ability to control risk under a variety of scenarios, clearer client communication via explicit quantification of the change in expected future after-tax wealth and the performance of the portfolio under selected scenarios, elimination of model-based and rule-of-thumb allocations, and better portfolios through customization. The technique can both identify a client's risk budget and rebalance portfolios.