How to Put Goals at the Center of Your Investment Strategy

  • Goals-based investment management recognizes that fact and employs strategies designed to create ideal financial outcomes
  • Why goals-based portfolio construction makes sense
  • Managing risk within a goals-based portfolio

The importance of goals-based investment management strategies is becoming increasingly clear to financial advisors—and to their ever-more-sophisticated clients and prospects.

The fact is, the amount by which investors (a.k.a. your clients) under- or outperform the broad financial indices is of little consequence if they ultimately fail to achieve the most important goals they have set out for themselves through their lives.

Goals-based investment management recognizes that fact and employs strategies designed to create ideal financial outcomes—results that not only reflect investors’ real-world needs and objectives, but also help overcome their biggest real-world financial risks.

The limitations of traditional risk/return-based portfolios

To see the value that goals-based investment management brings to the table, it’s important to first acknowledge the limitations that are inherent in current day portfolio design.

Most portfolios are built using the tenets of modern portfolio theory and portfolio optimization, with the goal being to create a series of portfolios that reside on various points of the efficient frontier. Advisors can then help their clients select the specific efficient portfolios that are best for their situations.

Certainly it’s reasonable and sensible to pursue portfolio efficiency. The problem: That process is typically driven by various types of questionnaires designed to assess investors’ risk and return requirements. In most cases, the questions focus on identifying the amount of downside volatility investors can withstand without abandoning the investment strategy.

In other words, long-term portfolio allocation decisions are being driven primarily by downside volatility and short-term risk considerations instead of by goals across investors’ lives.

This creates a disconnect. Typically, an investor’s answer to these risk-driven questionnaires is some version of, “Give me the highest rate of return I can get with the lowest risk.” That results in a traditional balanced portfolio allocation (along the lines of a 60% stock/40% bond portfolio, for example). Advisors assume that this balanced mix, crafted around short-term loss tolerance, will enable clients to stay on track through a full investment cycle.

That’s the theory. But what happens in reality? When markets don’t behave as we want them to, clients lose faith and abandon their plans—needlessly jeopardizing  their futures. As anyone who has ever seen the well-known annual Dalbar data knows, investors’ returns fall far below the returns of their underlying investments. And one big reason is that portfolio design doesn’t focus on what truly matters: goals.

Why goals-based portfolio construction makes sense

In contrast, a goals-based approach to investment management doesn’t let short-term risk dominate the decision making process. Instead, it seeks to make portfolio decisions that reflect the actual stages that investors go through in their own lives—from accumulation toward life goals (the “gain” stage) to the actualization of those goals (the “protect” stage) to distribution (the “spend” stage).