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Goals-based investing: a widely used term without an all-encompassing definition
11 April 2023
Goals-based or also goal-based investing is becoming increasingly popular. It represents the next level of client-centricity compared to traditional investment advice which assigns maximum risk based on a questionnaire of risk tolerance and capacity.
Goals-based investing, however, is a term widely used and partially misused. It often goes hand in hand with terms such as financial planning or cash flow / wealth planning.
In this blog post, we define the key functions of professional goals-based investing that separate it from financial or cash flow planning, and we define these functions to show the subtle differences, purely from our point of view.
According to our understanding, goal(s)-based investing links financial plans with quantified personal life goals to concrete investment/insurance solutions through optimisation, so that these life goals can be achieved, or that at least the likelihood of achieving them is improved.
The pre-requisites for goals-based investing
Financial plans must
- quantify all clients’ life goals
- be based on the complete balance sheet of the clients (considering all assets, including illiquid and non-bankable assets and liabilities)
- be reasonably easy to create – and maintain
Optimisations must
- have the capability of multi-goals optimisation and not only optimise one goal
- be based on insurance and investment solutions, and not only on savings/cash flows
- be based on a realistic risk frameworks and outline capital market scenarios realistically
- be bespoke and individual to the client-specific situation (both on asset allocation and investment instrument level)
Definitions of the above terms
- Quantify life goals: When life goals are quantified, they can be allocated to one of three categories of financial goals, namely any type of cash flow goal (one-time vs. recurring expenses such as children’s education), vs. wealth goals such as capital preservation vs. return goals (e.g. 2% return after fees). Due to the broad definition, it becomes clear that every individual has some kind of a financial goals.
- Complete balance sheet: Includes all assets and liabilities, including non-bankable assets such as property, private equity, private debt, and art, as well as all liabilities (all types of loans) and risks that may lead to future liabilities such as disability.
- Easy-to-create and maintain financial plans: There are two approaches to creating financial plans. In most cases, the so-called net approach is sufficient, where everything is based on net income after tax. The net approach results in an input-light approach, as opposed to comprehensive financial planning solutions that detail taxes in all aspects but are also much more input-heavy. An input-light approach makes it easier to update financial plans.
- Multi-goal optimisation: While optimising one financial goal is easy, optimising multiple financial goals with different durations is much more difficult, but also reflects some of the trade-offs we face in life, e.g., children’s education vs. secure retirement income.
- Insurance and investment solutions: optimisations in annuity products or different investments allow clients to optimise their balance sheet without increasing their savings rate
- Realistic risk frameworks: Must be multi-period (different return assumptions over time) and include capital market crises / fat tails (non-normal distributions re. expected returns) – see our blog post here.
- Bespoke and individual solutions: While bespoke investment solutions at the investment instrument level have gained popularity in the recent past, strategic asset allocations still are mostly standardised (e.g., called income, balanced, growth and the like). This is a serious shortcoming, as it accounts for 90% of portfolio volatility over the long term. Ideal goals-based investment solutions create bespoke asset allocations and portfolios that meet clients’ needs.
Goals-based investing vs. Financial/Cash Flow planning
Several terms are used interchangeably, as mentioned above. The below overview aims to differentiate these terms. Please note that this represents our view only.
Criteria
- Value Proposition
- Scope**
- Goal-types and limitations
- Wealth forecast
- Input effort & elapse times
- Client-facing possible
- Optimise with investment solutions
- Optimisation with insurance products
Financial Planning
- How much to save to achieve my goals? How to save taxes?
- Full balance sheet
- Focus on cash flow goals and savings
- Unrealistic: same consistent return over the planning horizon
- High (> 1 day)
- No
- No
- Yes
Cash flow Planning
- How much to save to achieve my goals?
- Only bankable assets
- Focus on cash flow goals and savings
- Unrealistic: same consistent return over the planning horizon
- Low
- Various solutions
- No
- Yes
Professional goal-based investing (ALM*)
- How much to save and how to invest to achieve my goals?
- Full balance sheet
- Comprehensive focus on all financial goals, on savings and on investment returns
- Realistics: thousands of scenarios with different returns/ fat tails over the planning horizon
- Low
- Yes
- Yes
- Yes
*Asset Liability Management (ALM) optimisation is a USP of 3rd-eyes analytics
** Relevant as illiquid assets can be leveraged or sold to improve goal achievement
Other terminology
In addition to the above, wealth planning, tax planning, succession planning and retirement planning are also widely used terms. Wealth planning is often used in the broadest sense, encompassing wealth structuring, tax planning, retirement planning and intergenerational succession planning, while the other terms are more focused.
However, as noted above, definitions vary from provider to provider and are not all-inclusive. We hope that we have given you some transparency as to how we differentiate ourselves from financial planning and cash flow planning providers.
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