What is the difference between required return and desired return?

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AcadiFi · Accepted Answer

Required return is the minimum return needed to meet essential financial goals — the client's non-negotiable baseline. Desired return is what the client would like to achieve to fund aspirational goals (second home, larger bequest, early retirement). The gap between them is critical for framing risk.

If required return is low relative to the portfolio's expected return, the client has room to take less risk while still meeting baseline needs. If required return is already close to the maximum achievable return, the client cannot afford to underperform and effectively has low ability to bear risk, regardless of stated willingness.

Example: financial planner Xiulan Marchetti at Evergreen Shore Advisors serves client Mohinder Abernathy, 62. Required return to cover non-negotiable retirement expenses: 4.0 percent real. Desired return to fund his aspirational grandchildren college fund: 6.5 percent real.

With an expected balanced portfolio return of 5.0 percent real, Mohinder can meet his baseline comfortably but will likely fall short on the aspirational goal. The IPS should explicitly prioritize required goals and use a moderate-growth allocation, with any excess returns directed to the aspirational bucket.

This framework, sometimes formalized as goals-based investing or mental accounting, segments the portfolio by goal priority and assigns different asset allocations to each sub-portfolio. Practitioners at Brinson, Dimensional, and BlackRock have popularized this approach. For CFA Level III, state both required and desired returns when both are identifiable, and recommend prioritization.

What is the difference between required return and desired return?

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