In short, advisers are more likely to succeed in meeting their client’s financial needs by adopting a Goals Based Investment (GBI) approach that encompasses dynamic asset allocation, than by following the traditional risk-based strategic asset allocation methodology that has been common practice over the previous few decades.
As a result, modern portfolio management is embracing GBI to achieve superior financial outcomes for clients, the essence of which is dynamic asset allocation; this involves adjusting investments in accordance with market conditions or the client’s changing circumstances and differs from strategic asset allocation, which asks investors to ride out market ups and downs. Portfolios applying a strategic asset allocation approach often suffer higher volatility which can also be damaging for clients in both the accumulation and drawdown phase, for example; sequencing risk. In contrast, the GBI approach helps reduce volatility, which in turn helps clients achieve the target return required to accomplish their respective objectives within their specified timeframe.
A key advantage of GBI over strategic asset allocation is its common-sense approach to risk management. In the end, an investment strategy is only as successful as the client’s ability to see it through. Erroneously, the strategic asset allocation approach assumes that investors are rational. In reality, they tend to be over-confident during boom times and over-react during market corrections. This can lead to poor investment outcomes when clients demand to switch to cash after large market falls, only to miss out on the subsequent recovery, in addition to tarnishing their relationship with their advisor.
On the other hand, GBI is aligned with actual investor behaviour as it utilises the mental accounting concept propagated by behavioural economics. This sees investors segregating their funds across various goals and assigning each goal a different level of risk, rather than viewing their investments as one whole. For instance, they may accept high risk for a small portion of their capital in an attempt to maximise returns, but prefer a more conservative approach when saving for important objectives, such as a home purchase or retirement. This correlates perfectly with a GBI strategy, which divides an investor’s capital among a number of goals that vary by target return and time frame.
GBI also defines risk in a way that most investors can accept. While the strategic asset allocation method defines risk as the standard deviation from a certain benchmark, GBI depicts it as not meeting a target return; an intuitive concept that is easily understood by clients. These key advantages of GBI makes it easier for clients to stick with their investment strategy, even during times of great market upheaval.
This is further made possible by the fact that GBI aims to minimise investment volatility through dynamic asset allocation, which not only switches in and out of asset classes in accordance with expected performance, but utilises a broader range of assets than the traditional strategic asset allocation approach. Rather than being limited to equities, property, fixed interest and cash, dynamic asset allocation may also adopt assets such as gold and currencies to boost returns and, importantly, it can move the allocation to cash during poor markets with few opportunities. This is more acceptable to clients than the passive strategic asset allocation approach, which assumes that markets will revert to historical averages over time and only rebalances an investor’s portfolio to their point-in-time risk profile following large market movements.
By applying GBI, advisors are finding that their relationships with clients are dramatically enhanced through a deeper understanding of their client’s needs, improved transparency and, of course, superior financial outcomes. As a result, advisors that embrace GBI can better demonstrate their value to clients, resulting in a thriving and successful financial advisory business.