There has always been an aim behind saving money. If we still had those pots the labels would say things like ‘household expenses’, ‘children’s education’, ‘daughter’s wedding’ and ‘retirement fund’. But the modern world of financing has enabled consumers to leave those clumsy envelopes and break their earthen piggy banks and deposit their money in banks or invest it in funds.
While some people save with a particular goal in mind such as buying a house or building a retirement fund, others save with the aim of getting higher returns. Human behaviour is driven by incentives and while setting a goal can help them to save in a disciplined fashion, it also helps adults completing their goals.
Bad habits
But we need to save more. A number of surveys and research reports have highlighted the poor saving habits of UK adults. For the majority, saving is the biggest priority, according to a survey conducted by BlackRock, followed by investing for a comfortable post-retirement life and paying off credit card bills and other debts.
While the majority simply like to invest to save and grow their wealth, smaller goals such as paying for a home, starting a business, providing financial support, financing children’s education were also prominent in the results.
In recent years, goals-based investing has become popular. In simple terms, it involves a methodology where investing is based on the needs or goals of a household or an individual. Analysts have said that financial advisers have been practicing goals-based investing for years now but the methodology has become more popular ever since the financial crisis when many investors lost money.
“I think a lot of people got hurt during the financial crisis and the funds they were in gave them capital losses which were higher than expected,” says Alex Farlow, head of risk-based solutions at Square Mile Investment
Since then, financial advisers and fund managers use goal-oriented funds to make it easy for investors to understand their priorities and match them with their risk tolerance.
“We describe the kind of goal outcomes-based investing in terms of putting the client at the heart of the investment decision rather than the investment company driving the outcome,” Mr Farlow says.
”We think about all of the funds that we look at in terms of our four outcomes. These are: capital accumulation, inflation protection, capital preservation, and income. We think investors throughout their life cycle will probably fall into one, if not all four, of those camps at some point.”
The focus on goals-based investing is centred on the individual investor. Fund managers have pointed out that investment strategies are specifically designed around each client’s personal goals and performance is then measured by the client’s progress towards achieving each stated goal.
However, sometimes investors can have multiple or conflicting goals. In these situations, rather than pooling all of investor’s assets into a single portfolio, financial advisers create a separate portfolio for each goal. The risk tolerance for these portfolios depends on the investment objective of the client.
“We think, from an end client, perspective, there are really only two broad aims,” says Nick Samouilhan, senior fund manager, multi-asset funds at Aviva Investors. “It ties up to what you want to do, where you are in life. If you are saving for something, saving for retirement, saving for a holiday, that is all about growing your capital. That is the first goal. The second is, once you have got some capital, how you live off that and not erode it over time. That is drawing an income from it. We can talk about it in different ways and phrase it differently, but ultimately, those are the two goals, which everyone has.”
While there has been an increase in goals-based investing, other events such as the introduction of pensions freedoms in the UK have also had people looking to their financial advisers for help in building their retirement pots. “Pensions freedoms have had quite a lot to do where the government has turned things around and said we are not going to look after you, and people need to take responsibility for their own retirement,” says Mr Farlow. “That means the onus is on the individual and that means them understanding what they’re going to get.”
More advice
This has led to a large number of people saving for their retirement and seeking advice from financial advisers to grow their pension pots. “Setting a retirement goal isn’t so much about asking people how much they need in retirement; rather will they have enough to maintain the lifestyle they feel they deserve,” says Simon Smallcombe, UK managing director at AXA Life Invest.
“It is about ensuring that the planning and advice they have received matches the client’s needs and demonstrates value. From our own research, we know that most people are risk averse and become more cautious as they get older. We also know that over three quarters of UK savers would be willing to pay 1 per cent more each year towards their pension pot in exchange for a guarantee on how much retirement income they would receive,” he says.
So how does one set up a process towards implementing a goals-based approach? According to Jean LP Brunel, a US-based wealth manager and expert on goals-based investing, setting up a goals-based process is repetitive.
The first step is to identify and describe the client’s main goals. This includes ‘needs’, ‘wants’, ‘wishes’ and ‘dreams’, ‘nightmares’, ‘fears’, ‘worries’ and ‘concerns’. The second step is to identify their respective time horizons, followed by identifying related cash flows or bullet payments. The final two steps include identifying the lowest funding cost for each goal and then finally deriving assets needed to meet each goal.
But the process of goals-based investing has its own risks and challenges. One highlighted by Mr Farlow is management of client expectations. “We have seen a couple of funds recently which have changed their objectives to more CPI-focused from composite benchmarks or peer groups.
“But the actual investment process has not changed. I think while people may say ‘okay I’m going to get CPI+ 4 per cent,’ they might see that as a target. It is kind of managing their expectations that they may not get 4 per cent above inflation every year and it is likely to be more volatile than that.”
Another risk with goals-based investing is customer’s lack of understanding of how a fund manager is going to achieve a promised target. “How a fund manager achieves a certain target is radically different from fund to fund,” says Mr Samouilhan. “I think that means that, while the outcome might be easier for clients to understand, it does mean some homework needs to be done in saying, ‘do I understand broadly what the person is trying to do to get that?’ and ‘am I comfortable with that particular style of investing?”
While each individual may have a different goal and thus a different risk tolerance, with investment of this kind, financial advice tends to play an important role in guiding investors to make the right decision. However, the first step is to set those goals. And then it is time to let go of those clumsy envelopes.
