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Invest with Purpose

Last Updated: June 3, 2016
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Over the past several years, investors have experienced a challenging investment environment. The financial crisis and recession of late 2008/early 2009 have given way to a prolonged upward trend in the domestic equity markets, with the S&P 500 moving from a recession trough of below 700 in March 2009 to new record highs above 1,900 as we write this. Along the way, however, there has been significant volatility. This environment has led some investors to consider abandoning a diversified portfolio approach and taking on much greater risk with higher levels of equity exposure; others are alarmed by the ever-rising stock market and are tempted to take their chips off the table altogether.

The question occupying the minds of many investors and their advisors is how to avoid these behavioral temptations. We believe a key element in building a sustainable investment strategy is to “invest with purpose.” And, the first step in investing with purpose is to understand exactly what each investor is trying to achieve with their wealth.

Know One’s Goals

Setting clear objectives is central to a goals-based investing approach. This is a dynamic and ongoing process of assessing goals and aligning a customized investment strategy with each of these goals. We believe that goals-based investing delivers immediate and tangible benefits.

  • An investment strategy based on an understanding of specific personal, family, dynastic, and philanthropic objectives delivers greater potential to achieve goals versus just trying to beat an index or benchmark
  • For investors that are unclear on what their goals are, this approach provides a completely objective framework to help them define what they hope to accomplish with their wealth
  • Developing and setting goals promotes ongoing dialogue between investors and their advisors in order to optimize their portfolios around circumstances that can change and evolve

Arriving at a customized portfolio asset allocation that is appropriately tailored to meet an investor’s prioritized goals can be a quintessential determinant of success, the importance of which cannot be overstated. This approach limits the uncertainty or misalignment of either taking too much risk or insufficient risk to meet objectives. The process of translating an investor’s goals, orienting them around the purpose for investing, and distilling that into the appropriate risk profile and investments within the portfolio is one of the most important aspects of a client/advisor investment relationship.

From Modern Portfolio Theory to Goals-Based Investing

Traditionally, a single comprehensive asset allocation strategy was developed for wealthy clients based upon their risk parameters, time horizon, unique circumstances, tax situation and other criteria. Utilizing Modern Portfolio Theory (MPT), portfolios were designed using a range of investments to provide an overall potential for a single growth preference and control of risk. However, in practice this approach could leave wealthy investors somewhat bewildered regarding how their investment portfolio was constructed and why.

In real life, investors often have more than one goal, with a range of views on how important each goal is. The MPT approach, while well-founded on historical information, did not effectively communicate to investors if one or more of their goals were realized or not. In essence, the market-focused approach of MPT often led investors to react emotionally to market movements. And, when short-term investment performance diminished the connection between strategy and realized results, investor dissatisfaction could grow – the very thing MPT was designed to prevent.

We find that a better approach in wealth management is for advisors and their clients to focus on the variables over which they can clearly demonstrate some control. This can help mitigate “emotional investing” as well as continually demonstrate the direct connection between a steady investment hand and the achievement of measurable goals. Creating the link between an investor’s goals, or purpose for investing in the first place, with the construction of their portfolio (and how the two relate) is the key differentiator to a goals-based approach, and can help to avoid the behavioral pitfalls of investing.

Goals-based investing provides a framework to ask each investor:

  • What are your goals?
  • How important are they – for each specific goal, is it a need or a want and how much risk are you willing to take?
  • Is this a short-term lifestyle goal or a longer-term goal?

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Once goals, priorities and timing have been identified, a strategic asset allocation can be developed to provide the foundation upon which long-term investment objectives may be attained. The strategic asset allocation can be thought of as a set of neutral allocations to a core group of asset classes (i.e. stocks, bonds, cash, real assets, alternatives, and private investments) designed to target a specific risk/return profile – one that incorporates the multiple goals of the investor. When meaningful, tactical tilts and shifts can be made to provide greater potential to reach specific goals or to moderate risk, and thus incorporate market dynamics and dislocations observed at the time.

A More Logical Framework

This investing approach focuses investors on goals-based outcomes, moving the definition of portfolio risk from beating a benchmark or standard deviation (a risk metric used as the standard for the industry for defining risk in MPT) to the probability of achieving one’s goals. This can help investors remain disciplined in volatile times and avoid moves driven by emotional reactions to performance in the overall portfolio. It also provides a rational structure for integrating financial planning with portfolio management; another key input to success for high-net-worth investors.

Based on the goals that are set, risk can be budgeted specifically around each goal. For example, if we envision a pie, each slice might be a different size, representing the different proportion of dollars allocated to meet a specific goal. This visual clearly illustrates that the “slice” allocated toward meeting lifestyle spending needs would appropriately be invested in asset classes with far less risk than the piece associated with growing the body of wealth for future generations.

Although asset classes such as equity may experience shorter-term volatility, over a longer time horizon, they have historically outperformed other asset classes, even when factoring in the effects of inflation. In fact, historically, when equity investors had a ten-year time horizon, their investments in equities (as defined by the S&P 500 since 1970), have been positive 95% of the periods (assuming a full ten-year investment period). The historical consistency of positive equity returns becomes even more probable when one considers investors in equities that have a 20 or 30 year time horizon in stocks.*

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* Past performance is not necessarily indicative of future results. All investments involve some degree of risk, including loss of principal.

Aligning Investments with Goals – An Example

While private equity and selected hedge funds may offer the potential for higher returns, many investors are often reluctant to “lock up” their assets in these less liquid vehicles. These investments usually restrict access to invested capital for a specified period, due to the longer-term nature of the underlying investments in the funds. Private equity in particular, may demand long holding periods because it represents direct investment into companies that may be in a turnaround situation or in the process of building up to an initial public offering (IPO) or a sale. “But what if I need my money before the investment allows?” is a typical concern heard by wealth advisors.

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Clearly defining goals can serve to mitigate instinctive negative reactions to committing capital to an investment for a longer holding period by potentially validating or disproving the need for short-term access. GenSpring has experience helping wealthy families assign time and risk horizons to segments of their portfolio using a goals-based approach. When we uncover that the family’s primary objective is to pass on wealth to subsequent generations, with a relatively long time horizon to accomplish the goal, it often helps the client to see the appropriateness of allocating assets towards longer-term investments such as publicly traded equities and private equity.

If only a small portion of assets were needed to fund shorter-term lifestyle requirements, the client may begin to realize that there is no need for short-term access to the bulk of the assets, and the appropriateness of increasing allocation to private equity for legacy goals of the portfolio become more apparent. The paradigm of the portfolio shifts, from “I don’t know if I’ll even live to see the realization of this investment” to, “I realize now that I’m not truly investing for me, but that the purpose of a large portion of my portfolio is to benefit future generations of my family.” When a client’s portfolio is large enough to meet lifestyle needs without issue, it can lead to the transcendent thought that the main purpose for investment was not only to maximize the wealth’s opportunity to grow for the owner’s lifetime, but beyond. Time, like wealth, is a powerful tool which should be utilized to achieve success, however it is defined, and often for our clients, it spans generations. We regularly discuss the client’s progress toward achieving shorter-term and longer-term goals separately, so they are able to clearly see the benefits of utilizing goals-based allocation strategies in a unique situation.

Avoiding the Benchmark Trap

Focusing on goals and defining risk as the possibility of not achieving goals can help investors avoid utilizing benchmarks as the sole measure of investment success. There are several reasons why overemphasis on benchmarks may lead to suboptimal asset allocations and investment decisions:

  • The benchmarks selected may not relate to what an investor needs to achieve with their wealth, and, unlike an investor’s portfolio, benchmark performance is not affected by cash inflows and outflows
  • Investors may take on more risk than necessary in an effort to try to meet or exceed a chosen benchmark
  • Investors may react emotionally or try to time the market if their portfolios are not meeting the benchmark

More effective accountability stems from measuring progress toward meeting defined short-term lifestyle and longer-term goals measured in absolute dollars as well as custom blended benchmarks designed around each client’s asset allocation. We believe in combining these measurements with benchmarking of each of the portfolio’s component parts versus applicable indices. This enables us to hold each investment accountable for achieving its designated “role” in the portfolio. This goals-based approach to performance measurement can help both advisors and investors avoid trying to time the market if a benchmark is not exceeded in the short term. We believe that, if one can stick to a well thought out investment strategy for a longer time period, the potential for overall negative returns is mitigated.

This approach can also help to appropriately allocate assets toward each goal. Goals-based investing provides a structure that helps investors resist “borrowing” from one goal to meet another without generating a discussion of trade-offs to understand the implications of such decisions on the overall wealth enterprise and prioritized objectives. For example, an unforeseen change or market volatility may result in an investor considering using assets that are working toward achieving long-term objectives in order to increase liquidity. However, investors often do not realize the potential longer-term portfolio implications of withdrawals in terms of the cost to the portfolio.

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* Withdrawal takes place in year 3 combined with portfolio loss in year 3 (10% geometric average 10-year return)

A Dynamic Process

As many have experienced, goals and the priorities that investors assign them are not static. At GenSpring, we begin with a deep discovery process focused on understanding what our clients are trying to achieve with their wealth. Some of the areas which we explore are:

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We understand, though, that an investor’s situation, concerns, priorities and preferences can change over time. Goals-based investing encourages ongoing dialogue and conversation to help keep one’s investment strategy aligned with changing parameters. An investor’s asset allocation should be reviewed, at a minimum, every two years, and more frequently, if events dictate, adjusting to reflect changes in goals and circumstances as needed.

Ongoing dialogue and communication of changes in circumstances is critical because clients may not fully realize the implications of a change. For example, a younger couple with no children that starts a family will likely find that their allocation to lifestyle spending increases. In addition, if one spouse decides to stay home to care for their family, then cash inflows will decrease. This may result in the need to allocate a greater portion of the portfolio toward assets that are highly liquid to align with a short-term time horizon.

Goals, Defined – An Example

A challenge that many investors face is developing an understanding of what they want to do with their money and what is most important to them. Often, clients first sit down with us stating that they do not have any specific goals for their wealth. One GenSpring advisor encountered this exact situation with a new client, who was certain that he did not have any goals.

However, over the course of an initial twenty minute discussion, together we were able to identify and prioritize multiple goals, including both lifestyle and longer-term goals. As we continued our rigorous process and delved deeper into each goal, the client articulated very distinct risk tolerance parameters, based on the overall importance and time horizon for each goal. Based on this information, we were able to structure a portfolio to address multiple goals, such as meeting short-term lifestyle needs as well as longer-term philanthropic objectives. We meet regularly with the client to remain current on any changes, and the client proactively communicates any new developments of which we may be unaware.

Conclusion

Goals-based investing can provide investors with the foundation to build a disciplined long-term strategy that they can maintain under a variety of market conditions, we believe delivering greater potential to meet one’s goals. By measuring success with a yardstick of progress toward goals, investors can also minimize reactive behavior to shorter-term market volatility and movements.

Goals-based investing also allows for a careful selection of investments that align with multiple needs. It allows investors to be more cautious with parts of their overall portfolio while suggesting the selection of investments with less liquidity and more potential for return where appropriate. Goals-based wealth management delivers additional benefits as part of GenSpring’s integrated approach to investment and wealth planning. For example, clearly articulated client objectives allows us to introduce and align objectives with effective tax and estate planning. Addressing a philanthropic goal may point to the utilization of trust with beneficial tax structures for charitable intent. Clearly quantifying and prioritizing client objectives can lead to multiple benefits for investors both in pure investment management and in terms of wealth planning.

However, defining and understanding multiple goals and risk profiles can be a daunting task to undertake on one’s own. An experienced advisor can help uncover the information and perspectives necessary to craft an effective goals-based investment strategy. GenSpring advisors have developed a deep expertise in working with their clients through a dynamic and ongoing process designed to help them achieve their short- and long-term goals. We invite you to learn more about goals-based investing by contacting GenSpring at 866.506.1989 or visiting us online at www.genspring.com.


Authored by GenSpring Investment Advisory Center, with contributions from Kevin S. Campbell, Family Investment Officer


Disclaimer

The information contained herein is for informational purposes, and should not be considered as investment, legal, insurance or tax advice, or a recommendation for any particular security, strategy or an offer for investment advisory services. The material is in summary form, and should not be relied upon as being complete. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness.