Investing and getting a return on that investment is done to achieve a certain outcome whether it be retirement, a house purchase, etc. Goals-based investing (sometimes referred to as objectives-based investing) is a method of allocating certain investment assets to target that particular investment you are looking for a return on in a more specified way.
Goals-based investing not only involves determining your risk tolerance; but it truly focuses on you articulating your specific financial goals and objectives. You can then work with your financial adviser to construct an investment portfolio that will put you in the best position to achieve those goals and objectives.
Let’s look at a simplified example of goals-based investing when it comes to retirement planning.
Phase 1- Accumulation
Jane and David Smith’s financial goal is to have a comfortable lifestyle in retirement, ASFA’s Retirement Standard has found this equates to a required income of $59,619 per annum. According to ASFA, a couple looking to enjoy a comfortable lifestyle in retirement will need approximately $640,000 in retirement savings to reach this income requirement (assuming eligibility for a partial Age Pension). Jane and David’s financial adviser takes this into account and also reviews their current assets and liabilities, capacity to save, the timeframe in which to achieve the goal and risk tolerance.
After having a good understanding of Jane and David’s circumstances, their financial adviser now understands the possible outcomes in relation to achieving their goals. The three possible outcomes are:
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• We can easily achieve this goal,
• We have to take on more risk to achieve this goal, or,
• We can’t meet this goal.
If the goal is achievable within an acceptable level of risk, their financial adviser can build an investment portfolio with targeted investment returns that aim to maximise the probability of achieving their financial goal ($640,000). However, if the goal can’t be met, either through unrealistic expectations or the need for an unacceptable level of risk, then the goal may need to be revised.
Phase 2 – Pension
As Jane and David reach retirement and begin to enter into the pension phase of their retirement planning, consideration may be made to altering the asset mix within their investment portfolio. This may involve reducing exposure to growth assets and increasing exposure to income-producing assets.
In combination with the three-bucket strategy, goals-based investing in pension phase may also see the investment portfolio broken down to account for various goals such as:
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• Safety. Precautionary savings
• Essential. Funding for day to day living
• Lifestyle. Funding for discretionary spending linked to a more active retirement
• Future. Funding to create a legacy or to meet aged care and medical expenses.
Subsequently, the portfolio would be structured to support the various goals. In an extreme example, you could have separate investment portfolios to achieve each goal. However, in practice, it is more common to have one investment portfolio mix, tailored to ensure it achieves the various goals.
Why is goals-based investing an important consideration?
Achieving investment returns is important, however when you have a direct link between the investment return you require to fund the financial goal you have, it makes the desired return more meaningful. You may not have to invest in a more aggressive way than what is needed to achieve your goals. In saying that, goals can change over time, as can personal circumstances and investment markets.
Goals-based investing enables you to clearly see how you are tracking towards your goals. With each review you and your financial adviser make, you are able to understand and gauge the performance of your investment portfolio in relation to your goals.
It is important to remember that goals-based investing can be used in considering all types of investments, not just retirement. Consider the way that you could relate saving for a deposit on a house by using goals-based investing to gauge the amount you need, your current financial situation and risk tolerance, the targeted time horizon, and the possible outcomes in trying to achieve this goal.
