How do you measure the success of your investment strategy? Most people look at their returns: five per cent is better than three per cent. But investment returns don’t tell the whole story. Whether or not an investment strategy is successful depends on whether it delivers the money the investor needs at the right time, allowing them to achieve specific goals.
That’s the aim of a goals-based approach to financial planning. Rather than chasing returns on investments, this approach identifies the amount of money required at different times throughout an investor’s life and structures separate investment portfolios, alongside debt management, insurance, tax and estate planning strategies, to help ensure the investor has that money available when it’s needed. Then, instead of checking returns against the markets, the investor evaluates success by measuring their progress towards each goal.
In addition to redefining success, a goals-based approach also redefines risk. After all, the true risk for an investor is not that an investment portfolio loses money this year; it’s that the investor falls short of their savings goals and can’t do what they had planned to do.
What are you saving for?
For most people, the answer is, “Lots of things!” But that’s a bit like setting a New Year’s resolution to “Do a bunch of stuff.” It’s not specific enough. And when goals are vague, it’s hard to know how much to save, which investments to choose and what level of market volatility you consider acceptable.
Well-defined goals, on the other hand, are more achievable. Knowing exactly what you’re working towards is a great motivator to keep saving. It also makes it possible to build a financial plan around specific milestones that help keep everything on track.
As a starting point for goal setting, consider goals many people share: a comfortable retirement, a new home, a cottage, a renovation, education (for children or for yourself) and travel. Keep in mind that some common goals stretch beyond a lifetime – for example, a desire to provide a legacy to loved ones or make a substantial donation to a favorite charity.
Let’s consider Maggie, age 40, who has three primary goals. She would like to take a year off work and go back to school full-time in three years, renovate her kitchen in six years, and retire in 20 years. Because the date she needs to access her money is different for each goal, so is her tolerance for market volatility. Maggie can’t afford for her savings to be worth less than they are now when she’s ready to hit the books. On the other hand, it’s okay if her savings for retirement are temporarily down three years from now, as long as they recover in time for her to have enough money to stop working when she plans.
Since Maggie’s goals have different time horizons and risk tolerances, it makes sense to create three investment portfolios – and that’s exactly what a goals-based approach does. Each portfolio will have a different balance of equities, fixed-income investments and cash: more fixed-income investments and cash for shorter-term goals, and more equities for longer-term goals. When Maggie reviews each portfolio, she can of course look at its rate of return, but the more important measure of success is whether she’s on track to achieve the goal that particular portfolio is designed to help her reach.
Of course, sometimes goals shift. Maggie may decide to keep working and take classes in the evenings. That may allow her to put a down payment on a larger home instead of renovating her kitchen. Maybe one of her teachers will connect her to a new job she loves and she’ll change her mind about retiring at age 60. A goals-based approach can generally accommodate new plans, as long as they’re not made at the last minute. Portfolios will simply be appropriately adjusted, and investors can start tracking their progress towards new goals.
Whether or not goals shift, all investment portfolios need fine-tuning as investors approach the date when they need to access their money. As each goal gets closer and the time horizon shrinks, the related portfolio allocation will have to reduce its exposure to market volatility to ensure it can deliver the right amount of income when that money is needed.
That said, a goals-based approach ensures that only the portion of money that’s required in the near future has its risk level (and therefore growth potential) scaled back. The rest of an investor’s money can continue to enjoy a greater opportunity for growth towards longer-term goals. The flexibility to precisely calibrate a portfolio to its goal, while leaving other investments to keep working towards other goals, is one reason a goals-based approach adds so much value.
Not only about investments
How do debt management, insurance, tax and estate planning fit into a goals-based approach? They’re other essential components of a complete financial plan and can contribute to the likelihood that an investor will achieve their goals.
Debt is a drag on any financial plan, slowing it down with every dollar in interest paid. Having clear goals in mind can be a powerful inspiration to pay down debt and get rid of that drag. Your advisor can recommend strategies to be debt-free faster, including targeting the highest-interest debt first and consolidating debt into a single account with a lower interest rate.
Unexpected events can derail the best-laid plans – and that’s where insurance comes in. Health and dental policies can help with the cost of medications, dental procedures and health-related services when needed. Disability and critical illness policies help protect the ability to meet goals by providing financial support in case an illness or injury prevents you from working. And life insurance policies can help ensure loved ones avoid financial hardship and can continue to make progress towards their goals after the insured person’s death.
Plan to reach your goals
With the right strategies in place, you’re much more likely to reach your goals. Here are steps you can take in the short term, medium term and long term to improve your financial well-being. Remember, every step you take gets you closer to your goals.
|Short-term steps||Medium-term steps||Long-term steps|
|Create a budget||Arrange insurance protection||Save for retirement|
|Start an emergency fund||Save for larger purchases||Develop an estate plan|
|Pay off debts||Plan for children’s education||Save for “nice to haves”|
Effective tax planning reduces the amount of money paid in taxes, providing more money to invest towards goals. Simple tax strategies include maximizing Registered Retirement Savings Plan contributions every year to get the biggest possible tax deduction and, where practical, earning the most highly taxed type of investment income – interest income – within a registered plan where money grows on a tax-deferred or tax-free basis.
For many people, the goals addressed by estate planning are among the most important. Estate planning can help make sure assets pass to beneficiaries efficiently and tax-effectively, establish strategies to meet the needs of a loved one with a disability and/or set up a generous gift to charity. It can both provide significant tax savings and ensure family members are well taken care of.
Speak with your advisor
Defining clear goals and aligning financial planning to meet them can help you make the most of your money and avoid common financial pitfalls. For example, knowing that overspending or paying too much in interest will jeopardize your ability to have the experiences you want in life may prompt you to redouble your efforts to trim your budget and eliminate debt. Meanwhile, knowing exactly how much income you need in retirement makes it less likely you’ll skip a few months of saving, because you know the precise amount of money you must set aside regularly to stay on target towards the future you want.
Furthermore, understanding what you need your money for and when you need it will help you avoid investments that are inappropriate for your situation and focus on the ones with the risk/return profile that suits you best. An added benefit is that when you know exactly why you’re invested in a specific way, you are less vulnerable to the distractions of market ups and downs and can stay invested towards your goals.
Overall, focusing on goals makes financial planning more concrete and less abstract, allowing you to mix and match strategies with a very clear idea of what they need to achieve. It can also clarify conversations with your advisor, giving them a well-defined job: to get you what you want when you want it.
We want to hear “Your Story” – Let’s talk about how a goals-based approach to financial planning can help you achieve your dreams.