Rather than make short-term volatility the paramount driver of asset allocation decisions, goals-based portfolio design emphasizes the two factors that are most important to investors in the real world:
- Time horizon—the amount of time they have to reach their goals.
- Probability of success—the likelihood of having the capital they need to make their goals a reality.
This, then, is the essence of goals-based investment management: Investing across a person’s entire lifecycle to meet the primary objectives of that investment capital, with a focus on time horizon and the likelihood of success.
For example, consider a client who has a limited time horizon until he needs to start funding a goal. He will need a combination of asset classes that delivers very low volatility, of course. Conversely, a client with a defined goal that is 20 or more years away from actualization will benefit most from a combination of asset classes capable of generating the highest rates of return over that defined period—regardless of the volatility that may accompany that portfolio.
Using this goals-based approach, short-term volatility is not something to be avoided—it’s actually an investor’s best friend, allowing for those higher rates of return that maximize the probability of turning a goal into a reality.
Managing risk within a goals-based portfolio
Of course, just because volatility doesn’t belong in the driver’s seat doesn’t mean it shouldn’t be a key consideration. As an investor begins to accumulate enough capital to achieve his goal and/or approaches the time when that capital needs to be readily available, risk mitigation becomes increasingly important.
Here again, the differences between a goals-based approach to risk management and that of more traditional strategies offer important advantages to investors. For example, risk mitigation tools can be used within the equity portion of a portfolio to dampen volatility. When the stock market declines, an equity-based wealth protection strategy might gradually shift a portfolio toward investments that are less sensitive to severe market corrections. When those risk conditions have eased, the portfolio is gradually shifted back toward its growth-oriented position. (Indeed, this is exactly what we have been doing with our portfolios during the challenging market environment so far this year).
Clearly, this is a different approach than simply bulking up on fixed-income and cash-based investments as a client approaches his goal. Mitigating risk within the equity portion of the portfolio can allow clients to maintain a higher exposure to stocks over time—giving them the potential to continue earning higher rates of return than they could get from an increasingly bond-heavy portfolio.
That ability to stay invested in equities for longer periods can significantly increase clients’ probability of their wealth lasting throughout what may be long, active—and expensive—retirement years.
Adding real value
Investment management that focuses on the goals that truly matter to investors—such as their ability to fund their needs, live the lives they want and ensure that their wealth lasts at least as long as they do—adds tremendous value, and helps differentiate those advisors who bring these capabilities to their clients. In the years and decades ahead, goals-based investment management will come to define the very best that our industry has to offer.