Goals based investing – a new way of thinking.
It all sounds so simple. But I guess one of life’s truisms is; “that which is simple is not necessarily easy”. This disconnect between knowledge and action has caused some advisers and fund managers to rethink the way they provide advice to clients and construct investment portfolios. It appears that for some clients the traditional diversified portfolio approach is a barrier to success as that portfolio can seem far removed from the client’s life.
In the real world our financial goals are driven by the things that we want to achieve. They are fluid in nature and many in number. Accordingly they have different time frames and can even compete with one another.
A traditional diversified portfolio, which is constructed with a single risk profile in mind, will include elements such as cash and fixed interest investments. These investments are generally more capital stable and hence suited to shorter term goals. That same portfolio is also likely to hold assets tasked with generating capital growth over the long term – equities or shares.
These different assets serve different purposes and are likely to perform quite differently, but, if performance is reported on as a whole, then the reassurance provided by these more capital stable components is sometimes “swamped” by the more growth focused parts of the portfolio. Furthermore, with this single portfolio approach the ownership of particular investments is generally not linked to any particular goals.
To combat the limitations of the traditional portfolio approach, a process called “goals based investing” is gaining an increased following.
Using goals based investing the client is asked to think more specifically about the financial goals that relate to their unique needs, desires and time horizons (i.e. when you want to access your capital). For example, one goal may be to grow capital over time faster than the rising cost of living. More specific goals such as tertiary education costs, or generating a reliable income stream to pay essential living costs in retirement, may also be identified.
Once the goals and the respective timeframes for each has been agreed, the importance of each goal can then be evaluated.
Armed with this knowledge the adviser can prepare specific recommendations that are designed to meet these individual objectives.
The resultant portfolio will have separate elements each of which is aligned with a specific purpose and timeframe.
The portfolio recommendations resulting from goals based investing are more tangible as they relate directly to that person’s life. A client experiences the success of seeing the fruition of their short and medium term goals on the way to achieving their long term goals. My anecdotal observation is that clients are more able to cope with the volatility that may occur with their retirement focused portfolio if they are also fulfilling their short and medium terms goals along the way.
At its best the goals based investing moves well beyond a “window dressing” exercise of just creating separate pools of capital. A true goals based process will involve portfolios that employ management techniques designed with the process in mind. Such portfolios will have flexible investment mandates to reallocate capital between asset classes, access to assets that can generate returns in a variety of market conditions and in-built strategies to protect against significant market falls.
And you can enjoy the benefits of goals based investing without coming into conflict with the principals of compounding returns. For those longer term goals the compounding effects can be maximised by using a more growth focused strategy in the knowledge that you will not need to call on this part of your wealth until compounding returns have had time to work their “magic”. For those short to mid-term goals the investment mix will tend to favour stability of return over outright return.
This approach succeeds in taking a simple idea and implementing it easily. Indeed it can be done.
Peter Ashworth is a Principal of New Zealand Funds Management Limited, and is an Authorised Financial Adviser based in Dunedin. The opinions expressed in this column are his own and not necessarily that of his employer. His disclosure statements are available on request and free of charge.
First published in the Otago Daily Times in September 2017
