The Philosophy Of Goal-Based Investment Planning

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By Dr. Michael Finke, CFP®

Dean and Chief Academic Officer

The American College of Financial Services

Most of us view our investment portfolio as numbers on a screen. However, investments represent money that we set aside for some future purpose or goal. Are we investing with that goal in mind?

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Viewing investments through the lens of short-term performance offers a limited perspective. We construct portfolios to minimize risk of annual volatility. There is little thought given to how and when the money is actually spent.

If the purpose of our savings is to pay for a spending goal such as a college education or an income in retirement, shouldn’t we focus on how well the strategy helps us meet our goal? This is the essence of goal-based investing. Instead of viewing the portfolio as a monolithic account that exists separate from our real life, think of investments as each having its own purpose. Money is saved in this account to pay for a retirement home at age 67. Another account may fund spending on essential expenses throughout retirement. Each goal has its own amount of acceptable risk. Each goal has its own time horizon.

Why is Goal-based Investing So Valuable?

Goal-based investing is valuable because it helps us understand why we are saving in the first place. If the purpose of the investment is to fund a home at retirement, we can imagine ourselves living in the home. The pleasure we’ll get from the sacrifices made today to live better in the future. We will be able to match the risk of our investments with the flexibility of the spending goal. Are we willing to take more risk in the hope of buying a larger house on the beach? Or are we unwilling to accept the possibility of living in a smaller house? By defining the parameters of the investment goal, we are better able to identify the right amount of risk with our investments.

Many advisors use goal-based investing to help clients focus on the long-term goal in order to avoid worrying about the inevitable short-run volatility from holding a risky portfolio to fund that goal. They can remind a client that losing money this quarter isn’t that important because they won’t spend that money for another 10 or 20 years. Focusing on the long run helps investors avoid the common mistake of moving money away from stocks after markets have fallen.

Most importantly, goal-based planning provides a framework for using tax efficient strategies when deciding where to place investments. If I’m going to buy a house at age 67, what type of account should I invest in? Is a 401(k) the best choice? Should I use funds from a Roth account? These are complex questions that require knowledge of rules and tradeoffs among accounts. And this is where we can identify the most quantifiable benefit of goal-based planning over monolithic investing. Some accounts perform better over shorter and longer time horizons, and others are more useful when taxable income is high or low. Knowing these strategies helps investors get the most from each dollar they invest.

By Dr. Michael Finke, CFP - read the full article here.

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