If goal-based investing is such an obvious concept, why aren't more advisors practicing it with clients? Neil Ringquist, president and chief operating officer of Advisor Software, has the answer.
What is goal-based investing and is it a completely new idea?
Goal-based investing is about directly aligning your investment strategy with your financial goals. Pension funds have taken a similar approach for many years, called "liability-driven investing." Goal-based investing brings this concept out of the institutional investment world and into the retail space.
Goal-based investing is founded on the idea that investors have financial goals, including retirement security, paying for the children's college tuition, etc. The objective is to align a portfolio so that it can best meet these goals. In contrast, traditional advice tends to align portfolios based on a client's psychological tolerance for risk. The result is that often, investors have more risk in their portfolios than they can financially afford to take.
How does goal-based investing help people determine the amount of risk they can or should take?
Rather than focusing on an investor's personal tolerance for risk, as in traditional approaches, goal-based investing looks at an investor's financial ability to take risk. That is, their assets versus liabilities.
First, an advisor using a goal-based investing approach will need to prepare a view of their client's household balance sheet. This means taking stock of the household resources, including investment accounts, real estate holdings, non-investment income sources such as social security and pension, and future earnings. In addition, an advisor takes stock of claims against those resources, such as liabilities and goals (college funding, expenses in retirement, etc.). From there, an advisor can set a quantifiable risk budget. This is the household's capacity to bear risk given the minimum level of liabilities and goals it must fund. This is a far more accurate risk assessment approach than the more subjective psychological assessment of risk tolerance.
How does goal-based investing help dial down portfolio risk?
Goal-based investing helps dial down portfolio risk by keeping an investor's portfolio aligned with their financial goals, as opposed to their retirement date, age or desire for outperformance.
For instance, an individual in their 50s with no idea how to invest may look to a target date mutual fund. But those funds, with 60 percent equity allocations on average, may be far too risky for this investor given their minimum goal thresholds. This is because traditional asset allocation methods may use one input to determine appropriate risk, such as time horizon. With goal-based investing, this investor's portfolio risk could be much lower because it is based on an accurate and personalized assessment of their household balance sheet, not simply a single input such as time horizon.
What is the difference between using a goal-based approach and asset allocation strategies such as a target-date fund?
Goal-based investing is personalized for each investor's unique financial time horizon, plan and objectives. It uses the investor's actual household balance sheet to determine portfolio risk. There is no stock "model portfolio" or plug-and-play formula. Why should every investor planning to retire in 2012 have the same asset allocation? The shortcomings of such approaches are clear.
With goal-based investing, an advisor has a truly holistic view of the household financial picture. In turn, this means they have a far more personalized approach to determining their client's appropriate portfolio risk compared to the simple time horizon input of a target date fund.
How does goal-based investing help financial advisors?
With goal-based investing, advisors are able to put their focus always on the client. The advisor's objective is to invest a client's portfolio in order to help their client achieve financial dreams, not beat an investment benchmark. When advisors deliver more personalized and relevant counsel to their clients, they're able to create a deeper relationship with clients and use their time more efficiently.
What role can goal-based investing play in investor education, from the advisor's perspective?
Goal-based investing helps advisors educate clients about the key drivers of financial and investment success. For example, for younger investors, the future earnings stream is a large component of the balance sheet. Therefore, their job and career are more important determinants of success than whether they buy an active versus passive fund. Also, goal-based investing helps the advisor demonstrate to clients goal trade-offs. Goals are not all or nothing propositions; goal-based investing enables clients to understand how they can prioritize goals with varying levels of funding and create more financial flexibility.
What do you see as the major trends in investment advice in 2010?
Connecting the investment strategy with the household goals will be a major trend in 2010. Technology is allowing financial institutions to capture valuable resource and goal information from households in a non-intrusive, less time consuming manner. The more information a client shares with the advisor, the more personalized the advice recommendation will be, and technology is allowing advisors to collect that information and distill it into an investment recommendation in a far more efficient way.
Neal Ringquist is President and Chief Operating Officer of Advisor Software, an advice solutions provider for advisors at major financial institutions. www.advisorsoftware.com
What is goal-based investing and is it a completely new idea?
Goal-based investing is about directly aligning your investment strategy with your financial goals. Pension funds have taken a similar approach for many years, called "liability-driven investing." Goal-based investing brings this concept out of the institutional investment world and into the retail space.
Goal-based investing is founded on the idea that investors have financial goals, including retirement security, paying for the children's college tuition, etc. The objective is to align a portfolio so that it can best meet these goals. In contrast, traditional advice tends to align portfolios based on a client's psychological tolerance for risk. The result is that often, investors have more risk in their portfolios than they can financially afford to take.
How does goal-based investing help people determine the amount of risk they can or should take?
Rather than focusing on an investor's personal tolerance for risk, as in traditional approaches, goal-based investing looks at an investor's financial ability to take risk. That is, their assets versus liabilities.
First, an advisor using a goal-based investing approach will need to prepare a view of their client's household balance sheet. This means taking stock of the household resources, including investment accounts, real estate holdings, non-investment income sources such as social security and pension, and future earnings. In addition, an advisor takes stock of claims against those resources, such as liabilities and goals (college funding, expenses in retirement, etc.). From there, an advisor can set a quantifiable risk budget. This is the household's capacity to bear risk given the minimum level of liabilities and goals it must fund. This is a far more accurate risk assessment approach than the more subjective psychological assessment of risk tolerance.
How does goal-based investing help dial down portfolio risk?
Goal-based investing helps dial down portfolio risk by keeping an investor's portfolio aligned with their financial goals, as opposed to their retirement date, age or desire for outperformance.
For instance, an individual in their 50s with no idea how to invest may look to a target date mutual fund. But those funds, with 60 percent equity allocations on average, may be far too risky for this investor given their minimum goal thresholds. This is because traditional asset allocation methods may use one input to determine appropriate risk, such as time horizon. With goal-based investing, this investor's portfolio risk could be much lower because it is based on an accurate and personalized assessment of their household balance sheet, not simply a single input such as time horizon.
What is the difference between using a goal-based approach and asset allocation strategies such as a target-date fund?
Goal-based investing is personalized for each investor's unique financial time horizon, plan and objectives. It uses the investor's actual household balance sheet to determine portfolio risk. There is no stock "model portfolio" or plug-and-play formula. Why should every investor planning to retire in 2012 have the same asset allocation? The shortcomings of such approaches are clear.
With goal-based investing, an advisor has a truly holistic view of the household financial picture. In turn, this means they have a far more personalized approach to determining their client's appropriate portfolio risk compared to the simple time horizon input of a target date fund.
How does goal-based investing help financial advisors?
With goal-based investing, advisors are able to put their focus always on the client. The advisor's objective is to invest a client's portfolio in order to help their client achieve financial dreams, not beat an investment benchmark. When advisors deliver more personalized and relevant counsel to their clients, they're able to create a deeper relationship with clients and use their time more efficiently.
What role can goal-based investing play in investor education, from the advisor's perspective?
Goal-based investing helps advisors educate clients about the key drivers of financial and investment success. For example, for younger investors, the future earnings stream is a large component of the balance sheet. Therefore, their job and career are more important determinants of success than whether they buy an active versus passive fund. Also, goal-based investing helps the advisor demonstrate to clients goal trade-offs. Goals are not all or nothing propositions; goal-based investing enables clients to understand how they can prioritize goals with varying levels of funding and create more financial flexibility.
What do you see as the major trends in investment advice in 2010?
Connecting the investment strategy with the household goals will be a major trend in 2010. Technology is allowing financial institutions to capture valuable resource and goal information from households in a non-intrusive, less time consuming manner. The more information a client shares with the advisor, the more personalized the advice recommendation will be, and technology is allowing advisors to collect that information and distill it into an investment recommendation in a far more efficient way.
Neal Ringquist is President and Chief Operating Officer of Advisor Software, an advice solutions provider for advisors at major financial institutions. www.advisorsoftware.com
