Most financial advisors today are disciples, in some form, of Harry Markowitz, the Nobel laureate who introduced us to Mean-Variance Optimization (MVO) and modern portfolio theory. If you’ve ever been handed a portfolio recommendation based on your risk tolerance, chances are it was born from this framework. It’s everywhere in the industry, and for good reason: it’s elegant, it’s mathematical, and it works—within its own constraints.
But here’s the thing: it’s not solving the problem most clients care about. The result is a wave of commoditized portfolios that treat volatility as the ultimate measure of risk and smooth market swings as the ultimate goal. In the real world, however, volatility is just a number recording the ups and the downs of your portfolio. What clients really care about is whether their portfolio will cover their expenses over the long haul. This is where Liability-Driven Investing (LDI) shines—by shifting the focus away from reducing portfolio volatility and toward matching assets with liabilities.
Let’s break this down.
Mean-Variance Optimization: The Industry’s Default
If you’ve ever worked with a traditional financial advisor, you’ve seen the output of Mean-Variance Optimization (MVO). The concept is simple enough: combine different assets (stocks and bonds) in a way that reduces portfolio volatility. The more volatile assets, like stocks, have higher expected returns, but they come with bigger swings. Bonds, on the other hand, provide a stabilizing effect—lower returns, but they help smooth out the ride.
In MVO, risk is measured by volatility, or the ups and downs of the portfolio over time. The goal is to find the optimal balance between risk and return. Put simply: how can we maximize returns for a given level of volatility?
The logic is elegant. Diversify your portfolio with stocks and bonds, using bonds as a covariance to reduce the volatility of the stocks. You end up with a portfolio that, theoretically, should be more efficient in producing returns while managing downside risks. The lower the correlation between assets, the more effectively you can balance return and volatility. This is how we get the classic 60/40 portfolio—60% stocks for growth, 40% bonds for stability.
Now, let’s be clear: Mean-Variance Optimization works—if your goal is to reduce market volatility. But that’s not necessarily what clients care about the most. Ask any client what their primary financial goal is, and it usually sounds something like this: “I want to make sure I have enough to retire,” or “I need to cover my expenses for the next 30 years.” It’s rarely “I want to minimize volatility.”
This is where MVO falls short. It treats risk as volatility. Clients care about volatility as it relates to their ability to cover their future liabilities. That’s a fundamentally different conversation, and it requires a fundamentally different approach.
The Commoditization of Portfolios
Because most advisors rely on MVO, the portfolios they recommend tend to look remarkably similar. They’re built around the same assumptions of beta (a stock’s sensitivity to market movements), correlation, and volatility. Toss in a dash of the Efficient Market Hypothesis, which assumes all available information is already priced into markets, and you get portfolios that don’t deviate much from the industry standard. In other words, financial advisors end up churning out commoditized portfolios—cookie-cutter solutions that assume your primary concern is managing market swings.
The industry assumes that if we can just find the right mix of stocks and bonds, you’ll be in good shape. But in reality, this approach doesn’t always align with the client’s true goal-making sure their expenses are covered, come what may.
Liability-Driven Investing: A Better Way to Think About Risk
This is where Liability-Driven Investing (LDI) comes in. Unlike MVO, LDI doesn’t care about minimizing portfolio volatility. Instead, it’s laser-focused on one thing: matching your assets to your liabilities. Your future expenses are treated as liabilities that need to be funded, and the goal is to ensure that your portfolio can cover those expenses when they arise.
In the MVO world, bonds are used as a way to offset stock market volatility, providing a hedge against portfolio swings. But in LDI, bonds are used for something far more practical: they’re a direct match for your future liabilities and uncertainty of life. High-quality bonds, particularly those that align with the timing of your future expenses, can provide predictable income when it’s needed.
Think of it like this: in MVO, bonds reduce volatility in the portfolio. In LDI, bonds reduce the uncertainty of meeting your future financial needs.
When we build an LDI portfolio, we’re not just aiming for a smooth ride in terms of returns. We’re aligning your assets—particularly high-quality bonds—with your specific liabilities. If you know you’ll need a certain amount of money at a specific time, LDI ensures that you have the funds available when the expense arises. In other words, we’re using high-quality bonds as the covariance to your expenses, not to the stock market.
By doing this, we’re removing a massive layer of uncertainty. It doesn’t matter what the market does tomorrow or next year—if your portfolio is aligned with your liabilities, your future expenses are covered. You’re no longer at the mercy of market volatility. You’ve insulated yourself against the very real risk of not having enough money when you need it.
A Highly Personalized Approach
Here’s where LDI stands out even more: it’s a deeply personal approach to financial planning. While MVO tends to churn out generic, one-size-fits-all portfolios based on how much risk the average investor can handle, LDI builds a portfolio around your unique financial situation. We’re not solving for market volatility; we’re solving for your specific liabilities.
LDI recognizes that no two clients have the same financial needs. Maybe you’re looking at funding your child’s college education in 10 years, or perhaps your focus is ensuring a comfortable retirement. The point is, your financial goals and expenses are unique to you, and your portfolio should reflect that. This approach is designed to ensure that your assets align precisely with your individual obligations, whether it’s a mortgage payment in 15 years, healthcare costs in 20, or living expenses in retirement.
By personalizing the investment strategy to match your exact liabilities, LDI removes the guesswork. You’re not relying on abstract market returns or crossing your fingers that your portfolio grows fast enough to cover future expenses. Instead, you have the security of knowing your financial plan is built around your real-life needs.
Removing Market Uncertainty
The beauty of LDI is that it shifts the focus from managing market risk to managing liability risk. Instead of trying to navigate the choppy waters of market volatility, we’re building a portfolio that ensures your future expenses are covered—regardless of what happens in the stock market. This removes a huge amount of uncertainty for clients. You no longer have to worry about whether your portfolio can handle a market downturn because your focus is on whether your liabilities are fully funded.
In contrast, MVO leaves you exposed to market risk. Sure, your portfolio might be optimized for volatility, but what happens if the market takes an unexpected turn? If you’re relying on stock market growth to fund your future expenses, volatility suddenly becomes a very real problem.
LDI, on the other hand, reduces that uncertainty by focusing on outcomes that matter: will you have the money you need when you need it?
Conclusion: A Personalized, Practical Approach to Risk
At the end of the day, Mean-Variance Optimization is a powerful tool—if the goal is to reduce portfolio volatility. But for most clients, that’s not the real goal. The real goal is covering future expenses. And that’s where LDI excels. It moves the conversation from minimizing market risk to ensuring your financial plan is built to handle the expenses life throws your way.
MVO is built around the assumption that risk equals volatility. LDI recognizes that risk equals the chance of not meeting your financial obligations. That’s a far more important conversation, and it’s why Liability-Driven Investing offers a more accurate, personalized solution to managing your financial future.
It’s time we shift from a commoditized, one-size-fits-all approach to risk management and start building portfolios that reflect the real, personalized needs of clients. Let’s stop solving for market volatility and start solving for life’s real uncertainties. That’s where real financial planning begins.
John Grubbs, CAIA®, AAMS®
Disclosures:
All information is provided in this publication for informational and educational purposes only, and in no way is any of the content herein to be construed as financial, investment, or legal advice or instruction. Meridian Wealth Management, LLC does not guarantee the quality, accuracy, completeness, or timeliness of the information in this publication. While efforts are made to verify the information provided, the information should not be assumed to be error free. Information in the publication may have been provided by third parties and has not necessarily been verified by Meridian Wealth Management, LLC. And does not assume any liability for the information contained herein, be it direct, indirect, consequential, special, or exemplary, or other damages whatsoever and howsoever caused, arising out of or in connection with the use of this publication or in reliance on the information, including any personal or pecuniary loss, whether the action is in contract, tor (including negligence) or other tortious action.
Meridian Wealth Management, LLC, dba Meridian Wealth Management is a Registered Investment Advisor in the State of Washington and certain other states. The advisor may not transact business in states where it is not appropriately registered, excluded or exempted for registration. Individualized responses to persons that involve either the effecting of transactions in securities, or rendering of personalized investment advice for compensation will not be made without registration or exemption.
