Goal Based Investing

Goal Based Investing

Mutual fund Investors have a clearly defined set of financial goals they want to achieve, such as maximizing their income in retirement, purchasing a second property, funding their children’s education, buying a new car or perhaps a combination of the above.

This broad range of goals is commonly addressed using asset allocation models, focused on optimizing asset class mix in order to get the best risk/return balance for the investor through distributions in mutual fund. Given how diverse these goals are, both in terms of immediacy and importance, it may not be the most effective approach for an investor. This is where goals based approach to investing can offer an advantage.

Typically goals based investing differs from traditional mutual fund asset allocation by linking separate investment portfolios to specific goals. Investors are willing to take different levels of risk with different goals, and by creating a separate portfolio for each goal, each with a different risk profile and time horizon, since it’s possible to tailor the allocation toward achieving a specific goal such as children’s education or purchasing a new car.

Let’s consider an investor who wants to save for an early retirement while simultaneously looking to fund the purchase of a second property. These competing goals come with different time horizons and importance; the amount of risk acceptable for buying that property in five years’ time will be different from a retirement date that’s twenty-five years away.

The traditional mutual fund asset allocation portfolio to cover both of these goals, and any others in between, the short-term focus of the first goal gets built into the risk profile of the asset allocation portfolio and can end up dominating the entire thing. The asset mix toward achieving the near-term goal has resulted in a conservative allocation, making it harder to meet later goals as effectively as possible. Unlike with traditional investing, where success or failure is generally measured against a market index, goals-based investing helps tie the mutual fund portfolio’s performance to life events. This can assist an investor ignore market noise and stay focused on their personal financial goals amid periods of market volatility and uncertainty.

Something Innovative?

Goals-based investing isn’t new; it’s essentially a more sophisticated version of the way household finances used to be managed. In the early day’s individuals would save money in separate envelopes—perhaps one for rent, one for bills, and so on—with anything left over perhaps going into a holiday envelope. Should an unexpected expense crop up, the cost would never be taken from the rent envelope, but could be drawn from the holiday fund if necessary.

It’s an elegantly simple approach that reverberates with many investors. Identifying what was once a pool into several goal-oriented pools, however, requires more effort, with mutual fund asset allocation, monitoring, and reporting necessary for each mutual fund portfolio. The good news is that with with advances in technology this process can be largely pain free.

Once you’ve decided that a goals-based approach could work for you, your investment consultant can work with you to understand your situation, your financial goals, short-term aspirations, & those further out. Together, you can then attribute a risk level and time horizon to each goal and build the best-suited risk-adjusted portfolios to help you reach these objectives. The result will be personalized distinct portfolios, managed and reported on separately, to help you achieve each individual goal.

Investors should begin by asking themselves some questions for each goal.

  1. What purpose, do you have in mind for your mutual fund savings?
  2. Over what time period had you planned to spend your savings?
  3. Do you foresee any need to access your savings prior to your long-term goals?
  4. How are you committed to adding to your current savings? 
  5. Do you have any need for income at this time from your investments, and if so, how much?

Your advisor and you can together come up with a different asset mix for each bucket. The advisor can then look at what rate of return you need to achieve your goals. If it’s not realistic, you may have to spend less or retire later.

Focused Mindset

Goal based investing allows a mutual fund investor to set risk parameters for goals depending on varying importance, measuring success or failure against each real world goal rather than looking at the stock market. Each mutual fund investor has a distinct set of circumstances and financial goals is the key to long-term financial success, but keep in mind that circumstances and goals are dynamic and hence need to be revisited regularly every year as the market continues to move up and down.
Lastly remember that it’s important to have the right focused mindset if you want to succeed in goal based mutual fund investing. Patient, determination and consistency are very essential and virtues in this method of mutual funds investing.