Why goals-based investing works

Ali Kazal, 2020

When it comes to advising clients on their investment portfolios, most financial advisors still use traditional financial planning structures and investment theory, where the output is a single ‘all purpose’ multi-asset investment portfolio and the goal for the advisor is to maximise returns for a given risk level – as well as to earn a reasonable fee.

But given today’s turbulent times, plus the disillusionment that many consumers have built up towards financial advisors, trust and confidence and alignment are issues that urgently need addressing. Chasing performance by attempting to select the next Raging Bull fund has been proven to be a poor way of earning long-term returns. Out-performing the index should rather be the metric of the fund manager.

The professional advisor’s skill and value should rather be measured on the depth and breadth of their understanding of their clients and the quality of their actions that give effect to achieving the outcomes that really matter most to their clients.

Goals-based investing – where a client’s individual goals are placed front and centre to their investment strategy and an emotional connection is formed with each specific goal – is a credible solution to this problem which has been proven to deliver beneficial results over the long term. As an added bonus for the advisor, as client satisfaction improves, so too does client retention and expansion. So what exactly is goals-based investing and what are these benefits?

It adopts the view of the investor, rather than the advisor

Essentially, goals-based investing is about moving from a product-centric approach to one that is far more client-centric. According to Dan Nevins’ 2003 research paper for SEI Investments, goals-based investing can be defined by several key features:

• It defines portfolio efficiency in terms of client goals, rather than only on traditional measures such as return and standard deviation.

• Rather than creating a single portfolio with one overarching target, it looks to match each client’s particular goal with an appropriate strategy containing a series of smaller, more specific goals.

• The strategy is re-evaluated over time, to remain consistent with any changes in these goals.

A more meaningful approach

Perhaps the biggest benefit of goals-based investing is that it makes the process more meaningful to the client. The focus is shifted from the funds that they already have to the desired future outcome. The future outcome is articulated as a SMART financial goal: specific, measurable, achievable, realistic and time-bound. It is a discrete goal that is easily understood and very visual.

Investing with a client’s concrete goals firmly in mind – whether it’s buying a house, sending a child to school or having enough money to retire comfortably – means far more to the client and keeps them motivated, as opposed to simply looking more generally at how their portfolio performs over time relative to competitors and indices.

If a client can clearly see that splashing out on an expensive holiday now will remove a certain amount from their child’s university fund and threaten the achievement of the goal, it’s much more likely to impact their behaviour and they’re less likely to get side tracked. With a goals-based approach, clients are constantly reminded of why they’re doing what they’re doing, which gives them a sense of control over a future that usually feels uncertain.

Clients and advisors frequently tell us that the more clarity they have around each goal, the higher the chance of achieving the goal, because it becomes their shared reality. Clients stop worrying so much because they understand so much more.

Anchoring goals during turbulent times

Turbulent times, such as those we’re currently in, may make it hard for clients to stay committed to their investment portfolios. But international research from firms like CEB Gartner have found that during times of extreme market volatility, the majority of investors who had a goals-based investment strategy made no major changes to their portfolio and kept fully invested. However, for those with a traditionally structured investment portfolio, only 20% stuck to the original investment course. It has been frequently proven that market timing is very difficult to do profitably and that the more rewarding strategy is to weather the storms. It’s clear that goals-based investing helps clients take a longer-term view.

Reducing jargon and simplifying investment

The average financial advice client isn’t overly familiar with technical financial terms, and may be confused about exactly what they’re investing in and why. With goals-based investing, the jargon is reduced, and so getting a client engaged is easier to do since they are able to understand better what is being done and why. This approach also changes the conversation a client has with their financial advisor, who may previously have been more incentivised on completing a transaction swiftly and earning advice fees, than providing tailored long-term advice.

Advisors who self-identify as professional advisors and aspire to be financial coaches will find that the goals-based advice route is a powerful alternative way of demonstrating that they are adding real value and changing their clients’ lives for the good.

Appealing to more learning styles

Do you prefer to read steps in an instruction manual, or would you rather absorb a single yet complex diagram when trying to understand how something works? Neuroscience has shown that all of us have different learning styles, including visual, auditory and kinetic. When it comes to investment advice, people with different learning styles will respond in different ways. The visual learner, for example, may be far more connected to a particular strategy if they have a vision board of the dreams they’re bringing to life as opposed to a long, jargon-filled written strategy. Goals-based investing is likely to appeal to a wider group of people because each element of the portfolio can be visualised. Instead of just being a set of numbers on a fund fact sheet, each fund is in fact a future, and very personal, goal.

In their white paper on goals-based investing, Australian financial advisory firm Advice Intelligence references the latest neuroscience research showing that brains are naturally protective, and therefore resistant to change – so the goal in mind needs to be highly positive and motivating. If, for example, the goal is phrased in a negative way – “You’ll run out of money when you retire” or “Private school fees are increasing exponentially each year” – new habits required to avoid these scenarios can be hard to adopt, due to the brain’s hard wiring against change. Rather, any investment goals need to be positive in order to successfully change a client’s behaviour and/or habits. This research also shows that goals should be tangible, in terms of an outcome they can see, feel or hear.

It’s empowering, enjoyable and enduring

One of the biggest benefits of goals-based advising is that it helps empower clients to live the life they really want, and to play an active role in the direction it takes. Even the act of thinking about and setting a goal is enjoyable, which is further enhanced by giving the client an easy way to monitor that goal over time. Goals-based investing takes the client out of a potential “victim” mentality where they’re controlled by their financial circumstances, to a place where they can take concrete actions to change their situation and get to where they want to go.

When it comes to goals-based investing, it’s important to realise that for the client, the goal is about the journey, or a series of journeys. Because goals require the client to look forward and see what specific things they’d like to achieve at a set future date, it’s far simpler to map these to investment strategies that are optimal. Goals-based investing works because it’s about turning a client’s future hopes and dreams into tangible, achievable targets, keeping them motivated to stick to their investment commitments and celebrating when those goals are achieved. And of course, then it is time to set new ones!