He would alter the model to reflect the additional asset class. He would assign it an expected return, a volatility, and correlation to other assets. He would change the model to reflect the fact that reducing the allocation to Smith Industries will require the immediate payment of capital gains taxes. He would then map out the efficient frontier that he faces given the embedded tax liability in his existing holdings. The curve would likely be steeper, reflecting the fact that he would have to pay capital gains taxes to achieve risk reduction. Taxable investors seek to maximize risk-adjusted expected after-tax wealth. The goal is not to maximize pretax return, nor is it to minimize taxes. There is a tension between the desire to maximize pretax return and after-tax return. This tension can be frustrating to investors and advisors whose background is in the management of pension funds and other tax-exempt assets. Properly managing taxable investor assets requires a much greater level of customization and an understanding of income and estate tax issues. Each investor is unique. Not only do they each have unique goals and estate plans, but they also have unique holdings. Customization includes an attention to each client's cost basis and holding periods on existing assets. The process that we have developed allows investors to optimally navigate this tension by relating investment decisions to after-tax results. It allows modern portfolio theory to be properly applied to taxable investors. NOTES Readers should not focus on the actual allocation mixes that we identified as optimal in these examples. The output reflected our inputs regarding expected return, risk, and correlations. In particular, allocations among the highly correlated taxable bond, municipal bond, and money market classes could swing dramatically based on small changes to these parameters. Changes in asset allocation within this group would likely have minimal impact on long-term results. What the reader should observe is the general tendencies of the optimal solution, especially the placement of tax-inefficient entities within tax-advantaged entities. Readers should recognize that modeling estate plans can be complex. Errors in the model can produce inaccurate results. At the same time, our experience in modeling has sometimes produced results that seemed odd but in fact were correct. The interplay between the tax characteristics of different entities is complex and the impact not always intuitive. The optimization process that we use includes year-by-year projections of each entity's balance and tax liability. Studying these projections often leads to insights into the unexpected interplay between the entities.