Why Goal-based investing is the best strategy for you in 2021
Money is never enough, and the journey of wealth building is unending. This is why investing blindly with no end goal in sight can result in investors losing track of their personal ambitions. Over time, investors can find it difficult to stay invested, and to continue giving up today’s spending for tomorrow’s investment returns.
This is where Goal-based investing comes in.
How is Goal-based investment different from traditional investment?
The key value-add that Goal-based investing brings, which is absent from traditional investing, is its ability to link up separate investment portfolios to specific goals. Different goals warrant different risk levels, time horizons, and portfolios. By having a different portfolio for each goal, investors can tailor the investment allocation accordingly to better reach their goals within the time frame that was chosen.
Here at LFA, the future purpose that your investment returns will serve matters to us. You are not putting aside your hard-earned money today for an unplanned future. Instead, your investment inputs today will help you achieve a future life milestone, such as purchasing a new car, holding a wedding ceremony, having a baby, paying for a child’s university education, upgrading your house, getting a steady stream of income after retirement, and more.
This differs from the traditional investing framework where investors simply work towards out-performance against the market average. In traditional investments, investors may say things like, ‘I just want to have more money.’ or ‘I want to take low risks over the long run.’, without any clear indication of the time period, and what the investment returns are for.
In these traditional investing frameworks, investors want to optimise risk and reward matrices, but are clueless about what to do with their wealth afterwards except to reinvest or save it. However, LFA believes that investments must come with a goal, and having an agenda will help investors ignore market noise and short-term volatility, as well as stay disciplined and motivated.
How does Goal-based investing work?
In short, Goal-based investing first decides on the investor’s ‘why’, before looking at the ‘how’.
Goal-based investing typically involves a discussion between the investor and a financial advisory firm like LFA. Together, the investor determines his life goals, and both parties work together to form a solid financial plan to achieve those goals.
Financial advisors value add by creating a customised financial plan to reach investors’ personal goals.
During the process, the financial advisor may also recommend some buffers to account for any possible changes in life plans, such as having a child, enjoying an earlier retirement, suffering from an unexpected job loss, and so on. All these buffers will be discussed with the investor, and will only be incorporated into the financial roadmap if agreed upon by the investor.
After coming up with the goals, a different asset mix can be assigned to each goal. The financial advisor can then advise on whether or not the rate of return is realistic, which will determine if the investment needs to be changed, or if there is a need to tweak the goal a little. Instead of retiring in 20 years, there may be a need to consider retiring in 25 years for instance.
When investors have a defined purpose of achieving a certain goal, they will be better able to decide on how much to investment, what strategy to adopt, the appropriate risk level, the time horizon, and more. The financial advisor can then build the best-suited risk-adjusted portfolio to reach these objectives.
In addition, investors will know what they can expect at the end - be it a luxurious two-week vacation in Europe, a brand new dream car, or a newly renovated home. This, in itself, is motivating.
How may a 40 year old do Goals-based investing?
Take for example a 40 year old investor who is looking to upgrade his accommodation from a HDB flat into a condominium in the next five years. He would also like to purchase a second house, ideally a studio apartment in a prime location in the CBD area, in 10 years to collect rental income. He also wants to retire at age 60.
These three goals have a different time horizon of five, 10, and 20 years, and have a different value and risk as well. Saving for retirement in 20 years is drastically different from upgrading into a condominium within five years.
Instead of having just one traditional asset allocation portfolio to address all goals, it is both clearer for the investor and more effective to create three portfolios to suit all three different life goals. Should there just be one portfolio, the short-term focus of the first goal of a home upgrade may result in the ultimate suffering of the long-term goal of retirement. Instead of having a higher concentration of conservative and stable bonds to ensure that the retirement nest egg is protected over two decades, the portfolio may prioritise on fast and risky returns to achieve the home upgrade within five years.
As evident, it is important to adopt Goal-based investing to prevent the skewing of asset mix and to prevent different near-term and long-term investment strategies from overlapping.
Is there an even simpler way to explain Goal-based investing?
If you are still unsure how Goal-investing is like, visualise how families used to manage household finances in the past. Cash could be placed in separate envelopes labelled ‘rent’, ‘groceries’, ‘kid’s education’, ‘weekend leisure’, ‘vacation’, ‘emergency’, and so on. Every envelope has its own purpose. You would not, for example, use the ‘kid’s education’ envelope for ‘vacation’.
In Goal-investing, these envelopes will grow in cash value over time to reach your objective.
Personalise your investments with your goals
Understanding your own unique circumstances and financial goals is the key to long-term financial success. As your personal goals and the market change over time, your financial advisor can be there to provide guidance.
Reach out to LFA to find out more on how our financial advisors can help you achieve your life milestones.