MOST OF THIS BOOK has focused on positive economics. We have created investors; given them preferences, predictions, and positions; let them trade with a set of available securities until they would trade no more; and then examined the relationships among security and portfolio prices, expected returns, and various measures of risk. Our focus was on the properties of equilibrium in capital markets.
But the actors in our plays made normative decisions as they sought to maximize their expected utilities. And they made these decisions by themselves. In the real world, only a minority of investors can and should attempt such difficult feats alone. In this domain, as in many others, the principle of comparative advantage dictates a division of labor. An individual investor can be aided by professionals with deep understanding of financial markets and the needed supporting technology and databases. Broadly, we will call such experts and expert systems financial advisors or simply advisors.
In some cases a person or firm will only make recommendations that the investor can accept or reject, then make the appropriate trades. Terms for advisors who operate in this manner include investment advisors, financial planners, and consultants. In other cases, an investment organization or individual will provide both the needed advice and its implementation. Terms for those who operate in this manner include personal investment managers and family offices. For convenience, we subsume all these approaches under the heading “advisor.”
This chapter is normative in nature, focusing on the ways in which advisors can help investors make the best possible financial decisions. We will argue that the need for personal investment advisors is growing in much of the world. And we will contend that it is imperative that such advisors make their recommendations or decisions in the context of logically consistent and well reasoned models of equilibrium in financial markets. We thus return to the theme introduced at the outset: asset pricing and portfolio choice are not two subjects, but one.