What's in the way of goals-based investing?

Despite the clarion call for holistic advice, investment advisors are still prone to building plans around misguided targets

What's in the way of goals-based investing?

To the average investor, an annual report reflecting market-beating portfolio performance may be a mark of a successful financial advisor. But as investment management gets increasingly commoditized and traditional performance drivers become less reliable, the fact that returns make up only half the equation should be abundantly clear.

The other half of the equation — the investor’s liabilities and objectives — should provide the foundation for any investment process, said Giuseppe Ballocchi, CFA and partner with Alpha Governance Partners.

“Comparing the merits of different approaches or product designs is beside the point,” he wrote in a recent article published by the CFA Institute. “What matters is the focus on the individual client, not generating superior returns, especially in the short term.”

Ballocchi emphasized the need for goals-based investing — the allocation of assets to meet financial objectives and address liabilities over multiple time horizons, while taking into account reasonable return expectations in capital markets. If there’s no feasible way to meet the targets, a decision must be made between adjusting ambitions downward and increasing available assets.

Read also: Why objective-based investing is set to return

 While this should be obvious to any good advisor, Ballocchi said that the way finance is conducted generally doesn’t support an integrated understanding of the client’s assets, liabilities, and financial objectives. He pointed to the silo structure of financial intermediation, notably for private clients who fall below the ultra-high-net-worth end of the wealth spectrum. “The cost of providing advice and a compensation structure often based on transaction costs and product sales makes this impractical,” he said.

Using incorrect risk measures could also contribute to the problem. While investment products such as mutual funds and ETFs get risk ratings based on their return volatility, advisors need to look beyond that yardstick.

“Risk simply materializes when assets are insufficient to meet the goals, resulting in a shortfall,” Ballochi said. “An obvious but painful and unfortunately rather common example is retirement risk, when retirees outspend their nest eggs.”

Another impediment comes from short-termism, which comes as financial professionals focus on quarterly or semi-annual results, rather than performance over years or decades, in order to manage career risk. Wealthy private clients with global footprints may also diversify across different financial firms without fully disclosing their circumstances and wealth to any one office.

“All of the above, together with the innate, deeply human overconfidence bias in decision making under uncertainty creates misplaced priorities,” Ballocchi said.

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