Goal-based investing: How comprehensive planning before investing ensures you reach the future you want
With the uncertainty the world is currently experiencing, it is more important than ever to understand why working with an advisor to develop a financial plan that incorporates goal-based investing is so essential to success in achieving what matters most to you. This articles describes the two biggest mistakes that investors make, and why the goal-based investing strategy is the solution.
For many managers, the performance of investment portfolios boils down to two main metrics: alpha and beta. Meaning: Managers attempt to bring together their performance edge, the alpha, and the proper asset allocation to be diversified, the beta. On the surface this may sound reasonable. However, this style of portfolio construction doesn’t always serve the client well. The reason? It’s not directly tied to the client’s own, personal financial objectives.
Time and again, we witness two financial shortcomings in a client’s investment strategy:
- not having clearly defined goals, and
- not investing according to a specific plan.
The foundation of a truly solid financial plan is rooted in a holistic, in-depth, detailed analysis of each client's liabilities and objectives. What will they owe, and what do they want to accomplish? Discovering the answers, and moving forward from there, is the core of goal-based investing. It is focusing on what matters. That is, the needs of the individual client, not on the blanket, supposedly-fits-everyone approach of a generic double-digit, often unrealistic return.
Ciccone-McKay views financial planning and risk management as inseparable mechanisms in reaching investment success. Through a fundamental understanding of your unique needs, we can better help you achieve success in all aspects of your finances.
BEFORE YOU INVEST, KNOW WHY
Whenever I had a major decision, I would always confide in my grandfather. I remember finishing high school and contemplating which university to attend. He responded to my asking his advice by asking me right back, "Where are you headed? What is your end goal?” Stumped, I admitted I didn’t know.
My Nonno said, not unkindly, "Then it likely doesn't really matter." In other words, if I didn’t know where I wanted to end up, if I lacked a defined goal, how could I make the correct decision? Needless to say, I then stopped drifting and focused on my future.
These days I often think back to that seminal conversation with my grandfather – because the importance of determining goals is just as true in successful investing as it is in making that early choice of postsecondary school. The first significant mistake that the average investor makes is not having the answer to: Why am I investing? Without a well-thought-out answer, it will be difficult to set the right strategy to fit your lifestyle needs.
So, don’t jump into investing. Take time to think. Setting up clear financial goals requires a clear vision of what you want to achieve. Ask yourself:
- What do you want your money to grow into, or to purchase?
- Are you saving for a home, an investment property, an education fund or a certain lifestyle in retirement?
- Is it a rainy-day account, for an emergency or opportunity, or…
- Is it something more fun, like a dream vacation?
Establishing specific goals is a central part of a well-rounded plan. Also attaching to each of these goals a specific time frame.
Okay. You’ve thought and decided. You know what you will be spending your money on and when. Now you’re not heading direction-less into investing, i.e., the let’s-see-what-happens approach. Unlike many investors, you’re being efficient and strategic. You’re being goal-based. You’ve outlined and defined your goals. Your why is answered.
YOU KNOW WHY. NOW WHAT?
Here’s where working with your advisor is key. With your goals and their expertise, together you will ensure the plan you develop makes sense and is realistic. Key in developing that plan is deciding the best way to allocate your savings: How much should go towards each goal.
With you, your advisor will address such vital next-step questions as the specific rate of return required, and accordingly, the corresponding risk level.
Risk is critical in your investment planning.More often than not, your portfolio risk is linked to the overall market volatility, that is, the fluctuation in the value of your assets over time. Additionally, the investment time frame you select is based on major milestones, for example: a new home, kids' college, new car or retirement income. As you can see, your time frame could span five years, 10, 25 or more.
In sports, risk applies to breakneck-speed car racing, or skydiving, or any number of thrill-seeking activities. In investment, the concept of risk isn’t as widely understood. It consists of two parts: ability and willingness.
Ability to handle risk involves a quantitative assessment, i.e., of your debt, as well as other circumstances that will affect your overall tolerance.
Willingness tends to be more emotional. Understanding willingness for risk, which differs per person, is how much you can handle and still sleep at night. Knowing your risk level is crucial. It allows you as an investor to stay on course through periods of extreme volatility and life-altering changes.
Accompanying your level of risk is your personal time horizon. Once you’ve defined your time horizons and goals, you don’t have to worry about taking on more risk than you’re comfortable with. You know your comfort zone and its limits. As Warren Buffett says: “Risk comes from not knowing what is next.” Through proper planning, you can be more aggressive in investing if your time frame is further away. Conversely, you’ll be more conservative for goals in a tighter time frame.
Investment planning is about matching your goals with your time frame — and then being disciplined enough to stick with those goals through all risk-Analystd events.
BUT IS YOUR GOAL FEASIBLE?
You’ve now identified the amount of money required to meet your goal. You’ve factored in the time frame for reaching it. Now you’re understandably wondering: Is the goal actually feasible?
Another way to word that question is: Based on your savings ability, what rate of return do you need to hit in order to achieve your goal? For example, you have determined that your annual investment return to meet your desired goal is 15% every year. Yet, historically, the stock market has only averaged a rate of return of 8% (adjusted for inflation). Most likely, you will need to make some readjustments to your goal, savings, and/or time horizon.
THINK CAREFULLY. ANY OTHER FACTORS UNACCOUNTED FOR?
There’s one thing you, like everyone else, can count on: the unexpected. It will occur, whether in your own life or – as we know all too well right now – globally. When the unexpected happens, it’s important to review your plan with your advisor and revise as needed. This could mean increasing a timeline, or the amount allocated to a certain goal, or evaluating the amount needed in a certain area.
The main reason people falter in their financial journey is that they can’t see their progress. So, they:
- quit out of discouragement
- quit out of fear of failing, or
- deviate far from their original plan.
This is mitigated with goal-based investing – because in setting a realistic investment goal from the outset, accompanied with timely checkpoints, you’ll always know exactly where you are. It’s such clarity that allows you as investor to maintain composure throughout your financial plan.
No question: There are many different levers to pull to hit your goals as an investor. But you can succeed as long as you start out knowing your goals. The alternative is throwing your money blindly at mutual funds without understanding the role they are playing in your life—and what they're trying to accomplish. Once your goals are defined, it’s just a matter of developing the best strategy, tailored to you as an individual, to reach them.