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Why So Siloed? The Importance of Goal-Based Performance Metrics


Life goals, career goals, financial goals – most of us have them. But for some, the goal-setting process is merely a formality – something an employer or financial advisor “makes” us do. And often, absent outside persuasion, we may never go back and see if we’re on track to achieve them.

Forced goal-setting often results in slam-dunk objectives with little to no emotional connection or true aspiration. Garbage in, garbage out. But when it comes to your assets, retirement nest egg, or vacation home fund, goals are often clear and emotions running high.

Yet, despite these clear goals, investors often look at their portfolio returns in a vacuum. Viewing performance metrics in conjunction with progress to achieving stated goals will not only give investors a much clearer picture on their financial status, but can also help avoid the hazards of emotional investing.

Asset allocation versus market indexes

The traditional investment strategy begins with asset allocation, where a client describes their long-term investment goals and risk tolerance and an advisor chooses an appropriate portfolio to meet those objectives. This can be a careful balancing act if the goals are aggressive but the risk tolerance is low. In the most common example, a young professional will want to focus on growth and would likely have a portfolio with a much higher concentration of equities as compared to a couple nearing retirement who are looking to preserve the wealth they have already accumulated.

Although asset allocation is an important part of any investment strategy, the absence of clear goals can sometimes pose a risk when investors review their performance. Suppose a person with a balanced investment portfolio and conservative risk profile is upset their return was 7% when the S&P 500 index was 12%. That client may decide to change advisors or seek higher returns through taking on more risk.

Why might this be a bad thing?

The client may not realize a few things. The S&P 500 index is a market index comprised only of equity securities. Based on their risk preferences and goals, the client has been put in a balanced portfolio, which may include fixed income and international equity – not just U.S. equity. The asset allocation is designed to limit risk outside of what is required to achieve the stated goals. Comparing his or her portfolio to the S&P 500 index is like comparing a three course meal to the á la carte menu. They’re just not the same.

Finally, reports on returns of market indexes doesn’t account for each individual investor’s cost of doing business, which makes any gap appear even wider. Any trade fees, advisor fees, commissions, or other charges wouldn’t be factored in. Conversely, the performance metrics as reported by an advisor would be net of all fees, and it is important to note that fee-only advisors do not charge commissions or sales charges.

A different kind of benchmark

Goal based investing is much more focused on results and progress towards an individual’s long-term goals. For example, after working through various assumptions with a CFP® practitioner, a client might determine they want to retire in 20 years with at least $2 million in assets. They would also like to pay for their daughter’s wedding next year and purchase a vacation home on Nantucket within five years.

By setting specific targets like this, advisors can work with their clients to calculate what rate of return they would need to reach these goals given the assumptions they’ve made on inflation, cost, time-horizon, earnings, etc. In this example, the investor might learn that they need an average annual return of 7%. This figure now becomes the client’s personal benchmark.

Aligning personal goals with portfolio returns helps investors view their progress without such heavy temptation to chase market returns, as it will help put their returns in perspective using a unique benchmark. During a market downturn, the headlines can even frighten a person with the thickest skin. However, by offering these targets for comparison, investors can concentrate on the long-term goals and less on the day-to-day volatility. After all, a bad year for stocks doesn’t necessarily mean you are no longer on track to meet your objectives, which is really what matters.

Of course market indexes shouldn’t be overlooked completely. They provide a very good gauge of market sentiment and what’s going on in the economy, which will impact every portfolio to varying degrees. Also, if an advisor is consistently underperforming a fund with similar risk, it could warrant further inspection.

As with any investment strategy, there are risks. The keys are to start early, work with a financial advisor to develop a solid plan based on reasonable goals and assumptions, and then stay the course. Need help building the framework for your financial future? Contact us for a free consultation today.

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