High Concept Strategies: Goals-Based Investing

This is the first of a series of articles discussing various types of high-concept investment styles. This month we start with goals-based investing.

Goal-based investing became popular after the Great Recession of 2008-09. Many salaried, middle-class workers lost their jobs, had to stop contributing to their 401(k) plan or, worse yet, had to make hardship withdrawals from it. These events triggered a realization that this blip in their long-term life plan could derail retirement dreams. For many, it may have been the first time they equated retirement investing with actual retirement income.

Goals-based investing is just as it sounds: you start with specific goals. It’s not focused on investing automatically with salary deferrals throughout your career, or obsessing over the right asset allocation based on your tolerance of market risk, or constructing an aggressive portfolio because you’re young and have a 40-year investment timeline. It isn’t about earning a certain percentage—like a 10 percent average annual return over 20 years.

The goals-based return on an investment is defined as achieving a certain goal, such as a sustainable income throughout a 30-year retirement, paying for two kids to earn a four-year college degree,or buying a second home on lakefront property.

In short, the goals-based approach is about achieving specific life goals utilizing investments as a tool to help you get there. This is an important distinction, as people learned during the most recent recession, because it ties your daily, monthly and annual decisions about money directly to your specific life goals. Once you buy into the goals-based philosophy, you may start better prioritizing money management decisions, such as not buying a motorboat until you’ve purchased the lakefront home.

Goals can and should be both short- and long-term. The first step once you’ve identified a specific goal is to determine the timeline for when you’ll need the money to fund the goal. This is easy with things like buying a house or your son’s college tuition. If he’s 2 years old, you have 16 years. If he’s 11, you have only seven.

Once you’ve established your investment timeline, this helps inform your asset allocation. At this point it’s important to define risk. In other types of investment approaches, risk refers to your tolerance for market volatility. But with the goal-based approach, risk refers to your fear of undershooting your goal. If you have only seven years to pay for college and you’re determined to get there, your asset allocation may be more aggressive than if you’re content to let your son start out at a community college, or consider the possibility he may earn a scholarship.

Once you’ve established your timeline and evaluated the risk of not meeting your goal, then, and only then, do you evaluate what types of securities in which to invest. That’s because the goal itself will help determine what types of securities to hold as well as the appropriate investment vehicles. For example, there are tax-advantaged plans specifically designed to help pay for college, healthcare and retirement.

With the goals-based strategy, note that other variables can affect investment decisions. For example, the more you save and contribute to your retirement portfolio, the less it needs to earn to meet your goals. Or, if you’re earning ahead of schedule, you might decide to modify your goals: retire early or buy a bigger lake house.

As you move closer to the time when you need the money, you might want to consider transferring portions of your portfolio to more conservative holdings to reduce risk of loss. Remember that with the goals-based approach, timeline is a key ingredient. As that timeline shortens, you’ll need to actively manage the portfolio to protect accumulated earnings while still working toward the specific goal.

And finally, you may wish to consider separating investments to achieve different goals. This is easiest to do with specific vehicles, such as a 529 savings plan for college, or an IRA for retirement. However, never lose sight of the fact that all of your investments combine into a single portfolio. Occasionally, take a bird’s-eye view of the asset allocation of the overall portfolio to ensure that your goals-based investment approach is not skewed too aggressively or too conservatively.

And, as always, it’s best to seek the knowledge of your Lewis & Knopf tax professional.