In a previous posting we looked at the difference between risk tolerance and risk capacity. It is our belief, borne out by experience, that Goals Based Asset Allocation addresses both risk factors.
Goals-Based Asset Allocation (GBAA) is an investment strategy that focuses on aligning an individual’s or institution’s investment portfolio with specific financial goals. Unlike traditional asset allocation approaches that primarily focus on risk tolerance and time horizon, GBAA takes into account the unique objectives and aspirations of investors.
The core principle of GBAA is to link investments directly to the desired outcomes, such as funding retirement, buying a home, or funding education. By defining and prioritizing these goals, GBAA enables investors to tailor their asset allocation strategy to meet specific targets rather than solely focusing on maximizing returns or minimizing risk.
One of the primary advantages of GBAA is its emphasis on personalized investment planning. By understanding an investor’s unique goals, GBAA allows for a more customized approach to portfolio construction. This ensures that the asset allocation aligns with the investor’s specific timeframes, liquidity needs, and risk preferences.
Moreover, GBAA recognizes that investors may have multiple goals with varying timelines and risk profiles. It enables the segmentation of investment portfolios into different “buckets” based on each goal’s characteristics. By doing so, GBAA provides greater clarity and transparency, allowing investors to make informed decisions regarding the allocation of their investments across various asset classes and investment horizons.
Another key aspect of GBAA is its focus on outcomes rather than short-term market fluctuations. Traditional asset allocation approaches often involve periodic rebalancing to maintain a predetermined mix of assets. However, GBAA recognizes that market volatility can impact progress towards specific goals. Consequently, the emphasis is on adjusting the portfolio’s composition to maintain alignment with the intended objectives, rather than adhering rigidly to a predefined asset allocation.
GBAA also promotes a more holistic view of an investor’s financial well-being. By considering both financial and non-financial factors, such as social preferences, philanthropic goals, and lifestyle aspirations, GBAA allows for a comprehensive assessment of an investor’s needs and desires. This approach acknowledges that financial success is not solely determined by investment returns but is also influenced by personal values and aspirations.
Furthermore, GBAA offers a clear framework for evaluating progress and making adjustments along the way. Regular monitoring of goal achievement allows investors to assess whether their current asset allocation is on track to meet their objectives. Adjustments can be made to the portfolio composition, investment strategy, or contribution levels to ensure that goals remain achievable despite changing circumstances or market conditions.
Ultimately, GBAA offers a more dynamic and adaptive approach to asset allocation that recognizes the unique needs, preferences, and aspirations of investors. By focusing on goals and outcomes rather than solely on risk and return, GBAA provides a more personalized and effective investment strategy. This approach enables investors to have a clear understanding of their financial journey, make informed decisions, and increase the likelihood of achieving their desired outcomes.
Overall, notional accounts or goal-based allocation offer a structured and psychologically sound framework for investors to manage their financial goals. By acknowledging and addressing behavioral biases, this approach helps investors remain disciplined, stay committed to their investment plans, and avoid making detrimental decisions based on emotions or short-term market movements.