REPOST: Goals-Based Investing: From Theory to Practice

Goal-driven investments are often considered the best kind of investments. The age-old practice of the ‘envelope system’ still applies today, but with much better savings options and are potentially more sustainable. More insights from Forbes:

Image source: Forbes
Image source: Forbes

What Is Goals-Based Investing?

In the world of financial advice, we are seeing a welcome trend toward goals-based investing. This trend puts a greater focus on the goals that investors want to achieve with their savings —such as retirement security, paying for college or purchasing a house — and uses these goals to drive investment strategy and monitor progress.

Goals-based investing may seem like an obvious concept, but it represents a departure from the typical risk-tolerance framework, which profiles clients based on whether they have a conservative, moderate, or aggressive orientation to investment risk. These distinctions are not just semantic; they have important implications for investment strategy and for wealth management practice, as we illustrate in this blog.

Risk Is Not Just Volatility

To see goals-based investment in action, consider a highly simplified example using long-term historical results for three different stock indexes: a large-cap index often used to represent “the market,” a small-cap index, and a dividend-payers index, all measured over the 40-year period from 1976 to 2015. Note that, during this period, equity markets enjoyed returns above their longer-term (1925-present) averages. Nevertheless, in this example we are focusing on the differences between the indexes. In addition, most investors would likely invest in bonds as well as stocks, lowering both overall return and volatility. Again, it is the relative differences that matter here.

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