Goals Based Investing – Stay Fully Invested

by Corey Philip
September 29, 2016

Goals Based Investing – three words that are changing the wealth management landscape in the 21st century. Until now, the wealth management industry used the ability to beat benchmark returns as the yardstick for performance. This approach to investment management worked well in boom cycles but posed significant challenges for advisors during the bust cycles. This was especially true during the 2007-08 financial crisis when investors felt their trusts betrayed when advisors still charged them advisory fees on portfolios performing poorly. As a result, goals based investing emerged to put client investment goals at the centre piece of advisory. The technological innovation in web-based advisory services have further popularized the idea of goals based investing as robo-advisors use this approach to offer tailored portfolio solutions for each of an investor’s investment goals.

Under the goals based investing (GBI) approach, each investment goal is independent of the other and has its own horizon and risk/reward profile. An individual saving and investing money does so to meet a certain financial obligation in the future, not to beat S&P500 by 200 basis points or more. Therefore, the premise of GBI approach is grounded in asset-liability management, which demands that future liabilities be appropriately funded. Robo advisors that do offer goals based investing allow an investor to choose from a list of goals, followed by questions on time horizon and risk tolerance. Using these inputs, a robo then assesses each goal in terms of a suitable asset allocation to offer an investor a portfolio that will be targeted to meet that specific goal.

To understand how it works, take the example of Betterment goals based approach. Betterment is a leading online investment platform that has really pioneered the goals based approach. It divides an individual’s investment needs into four buckets or goals.

Figure 1: Goals with suggested stock allocation, investment horizon, and withdrawal options (Source: Betterment)
Figure 1: Goals with suggested stock allocation, investment horizon, and withdrawal options (Source: Betterment)
  1. Retirement is where you can start planning for your retirement income either through a Roth or traditional IRA. Betterment allows its clients to invest in this account with a more aggressive stock allocation in the early phase of life and allocation risk adjusted downwards as the retirement age nears. The calculation takes into account factors such as the monthly desired retirement income and life expectancy to make recommendations on how much an individual needs to invest on a monthly basis to meet the retirement income goals.
  2. General investing is for people who want to grow their wealth over time by investing. Such a goal uses a long term horizon and utilizes an aggressive stock allocation of around 90%. Betterment adjusts the stock allocation at 55% at a later date. Such an investment account could be used for growing wealth over the span of decades that could eventually be passed on in inheritance or used to create a trust.
  3. Safety Net is that category of investment goals that serves an emergency fund’s purpose. Betterment has a fixed 40% stock allocation for this goal which is conservative, given the funds in this category need to be liquid in case a withdrawal needs to be made urgently.
  4. Major Purchase (House, Education, other) can be used for short to medium term horizon goals. Say you want to save up for down payment on a house. As you would need to liquidate this fund at a future intended date, the funds are invested conservatively with annual risk adjustments followed by monthly adjustments in the final year of the goal.

By subdividing investment funds into a few categories, each catering its own distinct purpose, Betterment has made it easy for an individual to be in complete control of his future financial obligations.

In order to demonstrate how asset allocation for a goal would look like, let’s examine another robo’s, TradeKing Advisor’s, goals based allocation. For an investor preparing to retire in 20 years, with a moderate risk tolerance and a long term horizon, TradeKing Advisors offers the following allocation mix.

Figure 2: Asset Allocation for a Moderate Risk investor saving for retirement (Source: RoboAdvisorPros)
Figure 2: Asset Allocation for a Moderate Risk investor saving for retirement (Source: RoboAdvisorPros)

It defines a Moderate Growth Portfolio as one with moderate risk and 60/40 stocks and bonds mix. The portfolio also includes 1% in cash and Real Estate and provides an overall balanced domestic and foreign market exposure.  As the risk level increases, stock allocation consequently increases and vice versa. Liquidity and tax considerations are also important concerns when using goals based approach, as they both directly impact asset allocation decisions.

It has become increasingly easy to identify important financial decisions with the help of such web-based investment advisors like Betterment and TradeKing Advisors. The end goal in the investing game should be matching your financial obligations – if you beat index returns along the way, even better!

About the author

Corey Philip

Corey Philip is a small business owner / investor with a focus on home service businesses.

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