A goals-based approach to investing is starting to gain traction with both the advice and asset management industries.
Goals-based investing is an approach that aims to better assist people in meeting their personal and lifestyle goals. It does this by placing the investor’s goals at the centre of the advice process and aims to build investment products that do the same. Customers develop a strong connection with the goals-based process and interactions with their adviser and asset manager are centred on how they are tracking against the goal.
A goals-based approach to both advice and investments also relies on a strong and engaging communication framework with customers. The framework needs to focus on delivering reporting updates that resonate with customers and connect with their stated goals.
Communicating relevant and easy-to-understand updates is critical for a successful goals-based framework. The update to a customer could be as simple as 'you are on track for a retirement income of x which is your target or you are not on track for your target and therefore need to work longer or contribute more’.
Points of Differentiation
Key points of differentiation between a goals-based approach and the traditional model relate to the advice model and investment products.
A typical advice model looks to recommend a diversified portfolio based on risk tolerances whereas with a goals-based approach, the investor is encouraged to distinguish and prioritise their goals into separate mental accounts or 'buckets’. Individual timeframes and investment strategies are then applied to each 'bucket’ to help achieve the stated goals. This approach means that goals-based investing provides a tailored approach directed specifically at meeting each of an investor’s needs, wants and aspirations.
The traditional method of investing typically combines a number of asset classes into a single portfolio. The portfolio is then optimised to target a specific return profile at the lowest level of risk, and generally aims to outperform a market benchmark or peer group. A goals-based approach, however, focuses more on total return outcomes or specific goals such as generating a reliable income stream. The success of a goals-based strategy, therefore, is measured by how well the portfolio is tracking against the investor’s stated goal, and not by how well it is performing relative to a market benchmark or peer group. It is important to note that for both traditional and goals-based approaches, principles of diversification and risk management are an important part of the portfolio construction process.
For an investment manager to deliver a goals-based solution, they need to be able to draw on a range of resources across the organisation from specialist investment teams to asset allocation. They also need to understand the advice process and bring customer insights into the investment management process.
While goals-based solutions can appeal to a broad segment of investors, the approach is generally more suited to those who are in or nearing retirement. This is because the goals associated with retirement can be quite diverse and vary from person to person, so adopting a more tailored approach to investing makes sense. As younger people tend to have more homogenous objectives (such as simply accumulating as much long-term wealth as possible to fund a comfortable retirement), a risk-profiling approach can be more appropriate.
Goals-based investing may also appeal to investors who need to maintain perspective and discipline during times of market volatility. This is because the success of a goals-based approach is measured by how well the portfolio is tracking relative to the individual’s stated goal as opposed to how well it is performing against a market benchmark or peer group.
Personalised reference points
Goals-based investing provides a more personalised and tangible reference point for the investor and can reduce negative behavioural biases such as impulsive decision making and overreaction to market events (either good or bad).
Insights from behavioural finance are now a key component of long-term planning and we are increasingly seeing advisers and asset managers use behavioural finance principles to engage with customers.
After the global financial crisis, when some investors saw a reduction in their retirement savings, investors became understandably emotional and exhibited everything from overconfidence, to belief perseverance, to mental accounting, to regret.
A goals-based approach has emerged as one of the best solutions to this problem and already it’s gaining traction in the US and the UK and increasingly within Australia. Instead of communicating with clients about particular portfolios, advisers begin by looking at the bigger picture.† Advisers try to assess a more realistic risk capacity. Goals-based investment advisers look at the client’s capacity to endure a downturn and ability to succeed in an upturn. †The adviser takes the focus away from beating a benchmark and towards a client goal.
One of the more tangible benefits of a goals-based approach is that customers discuss their dreams and goals with their financial planner and that the conversation centres on the client. When a solution is recommended to a client, it is referenced back to the goals of the customer and this can mean a stronger customer connection to the advice that has been delivered.
Craig Keary is AMP Capital Head of Retail and Corporate Business.